Volatility can feel like an investor’s worst nightmare. But it can also prove to be an invaluable tool for investors who know how to harness it.
For followers of legendary investor Warren Buffett’s two-step investment mantra, volatility would appear to be the enemy. After all, if rule number one is “don’t lose money”, then in the face of volatility rule number two feels as though it’s failed at the starting block.
There’s no doubt that volatility has the power to scare us witless and a tendency to catch us unawares. It’s the nature of the beast, after all. It might be stating the obvious but the real fear around volatility is in its unpredictability. Accept that volatility is to be expected and you can start to look at ways to harness it.
Exactly what the future holds has yet to be seen, but it’s likely that market volatility will still be around. As uncomfortable and as unwelcome as volatility is, it is survivable and, even more importantly, it can provide boundless opportunity.
Here are 10 important lessons for investors.
1. Volatility is a normal part of long-term investing
From changes in commerce (think of the high street/online retail tussle) to politics (Brexit; need I say more?), to trade wars, there is plenty to unnerve markets and cause volatility.
Yes, it might be unsettling, but it’s all ‘normal’. And it’s the ability to accept that and resist engaging in knee-jerk reactions that will keep you on track with your investment goals, come what may.
2. Long-term investors are usually rewarded for not shying away from risk
Investing in shares is riskier than keeping your money in cash, that’s a universal truth. But also true is that that risk is usually rewarded with higher returns.
3. Market corrections can create attractive opportunities
In a bull market, corrections - or to put it more colloquially, blips in the upward trajectory - are usual. And it’s these blips that create opportunity. The ‘window of opportunity’ to jump in and buy shares in a company or fund that is otherwise heading north, can be well worth taking.
While conventional wisdom says timing the market is a bad idea (it is, because you’re more likely to miss the opportunity than time it right) that’s not to say you shouldn’t pounce on opportunities when you see them. In times of volatility it pays to be on your mettle and keep your eyes peeled for opportunities like these.
4. A stop/start approach is lose/lose
This leads on from point three really and it’s a reminder that staying invested is the key, especially during times when investing can feel like a rollercoaster ride. When markets are going up and down spotting an opportunity and buying more during a correction is one thing, but jumping in and out is to be avoided.
Overall, staying invested is the best strategy to take. Otherwise you run the risk of missing out. You’ve probably heard it a million and one times, but it’s true that it’s time in the market not timing the market that pays off in the long run.
5. Regular savings stack up
Adopting a regular savings habit is a good way to stay on track with your goals, but it has the additional benefit of taking advantage of the ups and downs in the market too. When markets fall you automatically benefit by getting more shares or units for your money. This is known as ‘cost averaging’ because it can considerably lower the average price you pay for your investments. And, if you buy when prices are low, you reap all the rewards when they rise again.
6. Diversify, diversify, diversify
Second-guessing where, never mind when volatility will strike, is far from easy, which is why making sure you don’t keep all your eggs in one basket is key.
Having a mix of assets from shares and funds to bonds and cash, across different sectors and geographies is the best way to ensure that one spell of volatility doesn’t take your entire portfolio down with it. Spreading your assets means sharing the risks and is an essential for any investor.
7. Choose dividend-payers if you want a steady income
Company dividends are generally based on company performance; whether profits have grown, not whether the FTSE 100 isn’t flavour of the day. This means that if you choose to invest in high quality, cash-generative companies you can still expect stable dividend pay outs, even in times of volatility.
An additional benefit of opting for dividend-payers is that more often than not these also tend to be solid, global brands that typically operate globally, generating profits from a range of products and services across the globe, adding some additional diversification to your portfolio too.
8. Reinvest to boost returns
If you don’t need the cash now, then reinvesting your returns and letting them grow and generate their own returns can transform your portfolio. This phenomenon, known as compounding and allegedly referred to as the eighth wonder of the world by Albert Einstein, has a powerful snowball effect and can substantially increase your total returns.
9. Don’t blindly follow the herd
Easier said than done, but being able to resist general investor sentiment and rather than blindly following the herd, being more free-thinking in your investment decisions can mean you have the space to spot the opportunities the crowd misses.
That’s not to say that the herd always gets it wrong, but following blindly, without having your own good reasons for buying or selling, is a fool’s game. Being disciplined enough not to allow euphoria or undue pessimism to cloud your judgement will hold you in good stead.
10. Be an active investor
When volatility increases, being an active investor can reap rewards. It’s at times like these that an active investor or fund manager can spot opportunities and pounce on them. While passive investments can only follow the crowd - because they have to - active investors are free to spot over-sold or under-valued shares and funds and buy them at rock bottom prices. Leaving them well positioned when prices eventually bounce back.
Important information The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.