Weathering the storm
When markets are turbulent, it is natural to be concerned about how your investments will be affected. Yet, with suitable long-term planning, short-term market volatility need not be a concern.
The summer of 2007 provided investors with a stark reminder of just how unpredictable stock markets can be, as the “credit crunch,” higher interest rates and a number of other factors saw the markets beset by volatility – the rapid movement of share prices up and down. The media made much of this volatility, and those people who had investments either directly in shares or via managed funds were understandably concerned that they may lose some of their money.
The start of 2008 witnessed similar volatility and some financial commentators are forecasting more of the same later in the year, so it is important to understand exactly what market volatility is and why many commentators believe investors should consider such movements as normal, and healthy feature of stock market investing.
Understanding volatility
Stock markets go up and down all the time – this is typical of the way they work. Despite this, markets have historically followed an upward trend, even in times of short-term volatility (see chart). That said, fluctuations – both positive and negative – can be sudden and dramatic, and may catch even experienced investors off-guard.
In turbulent times therefore, it is all the more important to understand the fundamentals that underpin stock markets, and to look beyond the short-term volatility and consider market movements with a longer-term perspective.
When markets are volatile the immediate investor reaction can often be to move as far away from shares as possible and towards less risky assets like cash and fixed interest securities such as bonds. Most investors do not want to be associated with volatility and think that they will reduce their losses that way. However, by staying in the market, investors can take advantage of volatility.
The logical response of a volatile market is that it creates good buying opportunities as shares actually cost less. If you are a regular investor, you should take a long term view of your investment strategy and buy shares at their new lower prices. Indeed, many investment professionals believe you should invest in shares only if you can afford to take a long-term view. The reason for this is that over the long term, shares have outperformed both bonds and cash. If you are going to buy then you need to keep it simple, do not try and time the market as it is difficult to do this successfully. When you buy shares, look for diversification and do not put your eggs in one basket.
Timing the market – trying to spot the lowest of the low points, and the highest of the high is difficult. Diversification on the other hand is easy and effective. The starting point is an accurate assessment of your tolerance to risk. In volatile times you will feel very exposed unless your portfolio has been crafted around your own personal risk profile. The know-how of a financial adviser will ensure your portfolio represents a sound, individually tailored, diversified solution that aims to respond in accordance with the amount of risk you are willing to accept.
A volatile market has negative connotations but there are opportunities to be had. Serious gains can be made in certain shares at present, although I would avoid those shares that rely on consumer spending. One man’s fear is another man’s greed in times like these but it depends on an investor’s risk appetite.
Making the right choice
Picking the right stocks and shares, or for that matter the right bonds, is key to securing performance and successfully riding out volatility. But what are the right sectors to invest in? Here again diversification and expertise are key. Investment funds, run by professionals, well-resourced fund managers can offer a route to both.
You can pick investment funds that invest in stocks and shares, or bonds, or a mix of assets and you can choose to stay local or go global. Whatever you choose you have the expertise of a fund manager aiming to tailor their fund in today’s markets. The fact that any fund invests in a good range of different companies’ shares or bonds gives you diversification in itself. In calm times there is no doubt that this logic prevails. In volatile times, however, with the desire to “play it safe” the innate diversification qualities of investment funds, combined with the know-how of a financial adviser, can present a sound, individually tailored investment solution.
These days there is an increasingly large number of options available to you and your adviser, offering access to stock market investment within a range of risk profiles to match your needs. Cautious managed funds for example invest in less volatile assets such as bonds and “safer” shares, while there are “protected” funds offering capital protection on some or all of the initial investment. These (protected) funds do tend to become more popular when markets are volatile. Long term investors need to be sure these are suitable as they can lock you in for longer than the period of volatility might last.
At McLean’s we ascertain the client’s attitude to investment risk and then recommend a portfolio in keeping with this profile. It is very important to assess and review the client’s portfolio. We value our clients’ investments at least every six months and contact made every twelve months. This ensures the client is updated on prevailing market conditions and provides the opportunity to discuss their investments.
For more information or to discuss anything in this article feel free to contact Doug McLean via email or phone.
