Whilst there is often no single cause for market volatility, there are some conditions that can lead to it. In recent times, we have seen concerns about when interest rates and inflation, the perception of a housing market bubble, and instability in global affairs affect the ability of investors to obtain a reliable picture of the future. While these kinds of stories are not new and may not have triggered the recent stock market fall, they are some of the forces at play in the current market turmoil.
Volatile markets can trigger investors to question their strategy and to worry more about money. It is human nature that the experience of a loss is more acutely felt than the joy of a gain (‘loss aversion’). Uncertainty and a degree of volatility in the market will always be a constant; therefore, it is important for investors to keep perspective and be disciplined in their investment approaches. Some of the long-term fundamentals to bear in mind when dealing with volatility are:
1) No one can time the market
For most investors, equities should be included as part of their overall portfolio. However, ‘timing the market’ – that is, consistently selling high and buying low, is almost impossible. For that reason, we believe in the old mantra ‘time in the market, not timing the market’. In the last 20 years to December 2022 missing out on the market’s 10 best trading days resulted in over 4% per year of underperformance. The best trading days tend to cluster with the worst days, and it’s usually at a time when volatility is above average.
While volatility can test an investor’s resilience, active fund managers remove the emotion and view volatility as an investment opportunity. Stretched valuations in some stocks, and indiscriminate passive selling, create opportunities for active managers to add value through strict and skilful risk control.
2) Avoid emotion-driven selling
If the market has been performing well for a period of time, a pullback can often trigger an investor to take profits, while a more prolonged correction can lead to emotion-driven selling (or jumping between investments).
However, emotion-driven selling commonly will result in a lower long-term return on your portfolio, because you are then faced with trying to re-enter a rising market. Before making a decision to sell an investment three factors to consider are:
- What is your investment time horizon? If you are more than a few years away from retirement, or generating a long-term income, a market correction will likely seem like a blip in your investment history in the coming years (remember the Covid crash?).
- Are you remaining true to the long-term objectives when you established your investment?
- Fund managers are more adept at counter-emotional investing, as well as understanding the market fundamentals (however, even the best fund managers have periods of short-term underperformance).
3) Diversification
Trying to predict which asset class – be it shares, cash, fixed interest, or property, will outperform others in any one year can be as difficult as trying to time the market. In the last 15 years, each of these asset classes has had its periods of relative outperformance, but those that post the largest gains in good years, such as Australian property, can also be hardest hit when the market turns. If you are sufficiently diversified across the asset classes, your broader investment is hedged against periods of high volatility, and portfolio risk is smoothed out.
