Alex Neilson, investment manager at Investec Click & Invest, explains how to approach investing during periods of volatility.
Volatility is normal. Not only is it normal but its absence would see stocks deliver the same returns as cash. In his famous 1949 book, The Intelligent Investor, Benjamin Graham used the parable of Mr Market to describe how the stock market exhibits almost bipolar behaviour with its volatile mood swings, fluctuating between high highs and low lows. Understanding how that behaviour can affect us lies behind the golden rules for investing in volatile markets.
Get good advice
At some point in our lives, we could all do with a little expert help, no matter how competent we believe we are. Nowhere does this apply more than in our attitudes to investment strategies around volatile markets.
A good adviser can help you work out your goals, assess your circumstances and understand where your desire for higher returns bumps into your aversion to making losses. They can help you determine your investment horizon, or time frame, from short-term to long-term. Having done so they can discuss with you whether meeting your goals requires a conservative, balanced or aggressive growth strategy.
Have an investment plan and don’t change it
The French aviator and author Antoine de Saint-Exupery’s famous maxim – “a goal without a plan is just a wish” – applies perfectly to the world of finance and investment.
Deciding your goals in advance and writing them down will help prevent you succumbing to those twin afflictions of the investor in volatile markets: irrational exuberance and panic.
If you’re looking to build up a retirement pot, buy a better house or pay for your kids’ education, then a little choppiness is nothing to be concerned about. The longer the time-frame, the more risk is acceptable and the less impact volatility will have.
Smart investors ignore market noise. Periods of volatility tend to last weeks or months whereas your investment plan should be much longer term. Emotions have no place in the market – making decisions based on greed or fear, recency bias or loss aversion will not end well.
Get into the market as early as you can
Procrastination is best known as the thief of time but it could steal a fair chunk of your potential revenues as well. There’s a natural inclination to hang back from investing until markets appear to have stabilised. However, in volatile stock markets, heed the advice given by the King of Siam in the film The King and I: “Now is always best time”.
The sooner you start investing, the sooner your money starts to grow. Investing regular, affordable amounts on a monthly basis allows you to take advantage of the powerful effect of compound interest. Albert Einstein famously described this as “the greatest mathematical discovery of all time” and also as “the eighth wonder of the world”. Coming from the genius who gave us the general theory of relativity, that is praise indeed.
The combination of reinvestment of earnings and time can make a huge positive difference to your investment pot.
Be liquid but not too liquid
No one would recommend keeping all your wealth in banknotes sewn into your mattress. But having instant-access cash in the bank can be very useful: you won’t have to sell off your long-term investments to sort out a short-term cash flow hiccough.
Having some liquidity also means that you can take advantage of any buy-on-weakness opportunities presented by market volatility – as long as these are in line with your investment plan. Periods of high volatility in the markets can create great chances to buy blue chip stocks at discounted prices.
However, an environment of low interest rates and higher inflation erodes the value of cash. It makes sense to have more of your capital in stocks since the risk of not being invested can outweigh the risks of market exposure.
Spread your risk by diversifying
It may be a cliché but the advice about not putting all your eggs in one basket is very wise. Anyone whose portfolio was overweight in dot.com stocks in 2000 or bank shares in 2008 will testify to that. Thankfully, a bit of sensible asset allocation allows you to spread your money – and therefore your risk – across various different kinds of investment.
Typically, you would want a combination of stocks and bonds plus some property and cash. A well-diversified portfolio gives you some protection in volatile markets as each asset class will outperform and underperform at different times.
It’s also possible to diversify further within a specific asset class. Take equities: you may wish to sub-divide your money between value stocks and growth stocks, or micro-cap and mega-cap stocks (those with very small or very large market capitalisations).
An analysis of asset class performance over the last decade shows the value of this approach. The fortunes of Chinese equities, for example, see-sawed from top performer, returning 24.09% in 2016/17, to worst performer a year later with a rather dismal -13.46%.
It’s hard to argue with proven risk management benefits of a diversified portfolio. Multi-asset funds that invest in a mix of shares, bonds, property and cash are effectively ready-diversified portfolios that you can buy into.
Take a long-term view and don’t try to time the market
Good timing matters in everything from proposing marriage to telling a joke. But even the most sophisticated investors, armed with powerful algorithms and mathematical models, can come a cropper in trying to time investments in volatile markets.
Perhaps counter-intuitively, the 1930s Depression, the 1980s recession and the wake of the 2008 financial crisis all proved to be great times to get into the market based on subsequent stock performance over the next few years. If you look at, say, the October 1987 Black Monday crash on a graph that covers the period of a month then it looks disastrous. But when you see it in the context of the long upward trend in the bull market then it looks more like a blip.
The moral here is that we should be wary of our emotional responses to markets which tell us to buy during the boom times and sell up when the economy takes a dip. For deep-rooted psychological reasons, our outlook is more influenced than it should be by recent events and by loss aversion. The risk here is that we buy high and sell low, panic during market dips and follow the herd – the opposite of a successful strategy.
Playing around too much with our portfolio can result in unnecessary fees. Research shows that those investors who try to time the market receive lower average returns than they would have got with a simple buy-and-hold strategy.
Interested in reading more on the topic of volatility? Read what causes volatility and why now.
With investment your capital is at risk. The tax advantages of ISAs may change in the future and also depend on your individual circumstances.
Opinions given within this article are the authors own personal views. The views and opinions are effective from the date of publication but may be subject to change without notice. This article is not intended to constitute personal advice and no action should be taken, or not taken, on account of information provided.