No one enjoys market volatility but it is an ever present consequent of investing in financial markets. Investors have come to learn that there are several ways to improve upon their investment experience especially when markets become turbulent as they have on numerous occasions the past few years. Regardless of your personality type, lifestyle or comfort level, the investment strategies discussed below will help you navigate through various market environments.Keep emotions in check.
During periods of market uncertainty, it is common for some investors to get out of the market or to “park cash” into what they consider to be a safer investment option. Still, the evidence is conclusive that over long periods of time, constant switching between equities and fixed income or between any investments is a gamble. The reason it is a gamble is due to the difficulty that lies in two very important decisions that need to be addressed. The first decision is exactly when to get out of the market. Typically this is a lost cause as once a move is even considered, it is often too late as the market has already declined. The second decision is when to move back in, which is no easier. When investment decisions are guided by emotion, the tendency is to wait for a noticeably positive trend to emerge before taking action. By that time, it is usually too late, and the opportunity has passed by. Changes in your investment plan should be based on changes to your personal circumstances and your investment time horizon or risk tolerance. They should not be driven by anxiety.
Focus on the long term
Equity markets have inherent risk and as a result, market volatility is often very pronounced during short periods of time. However, with time, this volatility is substantially reduced. As shown in the chart on the first page, in any one-year period, the returns of the Canadian market (S&P/TSX Composite index) have been as high as 86.9% and as low as -39.2%; a range of over 126%. This is extreme volatility. However, if investors extend their time horizon, this volatility decreases significantly. For example, in any 20-year period, the returns of the equity markets have all been positive and have been in a much more narrow range. The five-year returns and beyond for the moderate portfolio were positive 100% of the time. This illustrates the advantages presented by a balanced portfolio in terms of risk reduction.
Diversify your portfolio
Equity investments are an important part of a detailed investment plan as they provide the necessary growth to achieve your long-term financial goals. On occasion, they are subject to short-term volatility, which is why a diversified approach to investment planning is best suited for most investors. Regardless of your investment timeframe, combining fixed income investments with your equity exposure will help you weather all types of market conditions. Effectively diversifying your portfolio goes beyond simply spreading your equity investments across several countries or regions. It is advisable to diversify your fixed income exposure as well, as not all bonds act in similar fashions. Short and long-term bonds for instance react quite differently to changes in interest rates and corporate and government bonds react differently to volatility in the bond markets. The market volatility we have experienced periodically in 2012 highlights the importance of balance between growth and stability in your investment portfolio.
Shut out the “market noise”
The daily economic news that you hear or read about can be troublesome and often distracting. Sometimes it leads investors to abandon their investment plan when there appears to be no light at the end of the tunnel. While it’s important to keep informed with what is occurring in the global economy, it’s even more important not to overreact to what is often referred to as “market noise”. Market noise is the delivery of economic and market-related information that investors are bombarded with in newspapers, online, and on TV. These news reports are short-term in nature and generally have no bearing on a long-term investment plan. The daily reporting of global events are often overstated to grab our attention or are one-sided to express an opinion. Investors should be mindful of this information but should not usually react to it. Staying focused on your goals will allow you to maintain your plan and not be derailed by short-term market noise.
Take advantage of dollar cost averaging
Individuals with a lengthy investment time horizon, who are perhaps nervous about investing in a volatile market environment, can actually take advantage of the low cost of equities without assuming a great deal of additional investment risk. While it is never known when equity prices will rise or fall, employing a dollar cost averaging strategy of investing at regular intervals, regardless of market conditions, can lower the average cost of investments and contribute to higher long-term returns. For dollar cost averaging to be successful, you must be consistent. If you abandon your strategy when markets are volatile, the purpose of dollar cost averaging is defeated as dollar cost averaging helps ease the stress brought on by volatile markets. What was once seen as a setback can now be viewed as an attractive investment opportunity. If you’re committed to regular investing, you won’t have to scramble for large amounts of cash when it’s time to buy. For most people, investing in smaller amounts on a regular basis is easier on the pocketbook.
- Remember investment strategies like keeping your emotions in check, diversifying your portfolio and shutting out market noise.
- Another strategy is to rebalance your portfolio, but keep in mind your expected need for portfolio growth, income, time horizon for investments and risk tolerance.
- At the end of the day, your investment strategy should be matched with your financial goals, timeline and comfort level with risk to achieve your investment goals.