Dealing with market volatility
In the last week we have seen oil prices drop to a 5 year low with double digit falls in less than a week. This has disturbed many countries that are dependent on oil revenue such as Russia, Nigeria and Norway. The markets can be affected by numerous factors and a sometimes we simply do not see these factors coming. Investors are twice as likely to react to a fall in value as they are to an increase in the value of their holdings, and markets drop twice as fast they rise.
The biggest gains or losses in markets happen in single day transactions. It is important not to sell a position as a reaction, as often the event you are reacting to is over, and sometimes markets over react then correct back to normal. It is highly possible to exit after a fall and then miss a gain compounding and crystallizing a loss. As a Private Investor there are some easy steps to follow avoiding irrational behaviour:
1. Take a long-term view (5-10 years)
Volatility in the stock markets has a typical cycle of 5 – 10 years. When investing, have a milestone for each investment, put this in the diary and ignore any movement before this diary date. Only allocate a small part of a portfolio to sector specific investments as this carries more risk and will, as a rule, be more volatile.
2. Avoid investing in overvalued portfolios, instead invest in stability
Past performance is never a guarantee of future success. When an investment has done well, that performance is not necessarily a trigger to buy that investment. Many investments are cyclical in nature and to understand the cycle is important.
With equities the price/earnings ratio (the price of the share compared with the earnings over a year or longer) should be considered. A higher ratio indicates overvalued stock. The consistency of dividend payments is also an important factor; the more stable companies are usually quite consistent with dividend payments.
Drip-feeding your investment into the market minimizes the risk of investing at the wrong time and creates an average purchase price.
Sometimes even the professionals get it wrong. For instance, one of the world’s greatest investors, Warren Buffett, rather than investing in riskier stocks has a reputation for taking long-term views on established companies. Recently he admitted making a mistake by backing Tesco and his Berkshire Hathaway investment company recently sold 245 million shares in the supermarket giant at a massive loss.
Therefore, being a private investor, it is advisable to spread your investment across a diversified range of funds, shares, territories, sectors and currencies in order to reduce exposure to individual holdings. This hedges against market movements and can have a less of an impact on your portfolio if a fund or sector performs poorly.
4. Be prepared
It is very important for investors to prepare for various outcomes by holding a broad spread of assets, bonds, shares, cash, fixed-rate investments and property. These assets are often negatively correlated giving a hedged performance. For instance, low interest rates have led to lower returns for savers and poor annuity rates have led to low pension returns. Therefore, having a mix comprising of more defensive funds can protect a portfolio irrespective of the climate.
5. Identify hot spots
Understand what is growing and why? With this knowledge, invest a small percentage in these growth areas via an expert. The more difficult the investment is to understand, the more an expert is needed. The investment should focus on a global portfolio without a home bias and be aligned to the Investors attitude to risk.