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October 2nd, 2013

Keeping an Eye on Market Volatility

 

Warren Buffet once said, “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that you’ll do things differently.” One of the most common mistakes investors make is not thinking holistically about their portfolio. Instead, they tend to examine each individual investment and overreact to the ones that are performing poorly or experiencing volatility – a recipe for financial ruin.

To both the novice and seasoned investor, volatility is the tendency of a market or security to rise or fall sharply over a short period of time. Changes in monetary policy, economic crisis and even the threat of war are forces that can contribute to stock market volatility. For example, in the energy sector, a major weather storm in an important oil producing area can cause prices of oil to spike in either direction. As a result, the price of oil-related stocks may follow suit. Some may benefit from the higher price of oil while others may be impacted negatively. This increased volatility can affect overall markets as well as individual stocks.

During volatile times, investors often become unsettled and begin to question their investment strategies. This is especially true for novice investors, who can often be tempted to pull out of the market altogether and wait on the side-lines until it seems safe to dive back in.

One way to overcome this urge is to invest in a mutual fund. The combination of stocks and bonds creates diversification which reduces the volatility and helps the investor maintain a reasonable allocation to equities without having to digest the full impact of falling equities in a difficult market. At the Unit Trust, we have an array of funds to acclimatize investors to the amount of risk they should accept in order to meet their long-term goals.

Regularly putting away money through a dollar cost averaging plan is recommended as a means of countering unpredictable price movements. By investing a fixed amount on a regular basis, regardless of the current market trends, investors are assured of a measure of insulation against changes in market prices and in this way one is able to minimise risk to their investment.

In this way, volatility gives shrewd Unit Trust investors the opportunity to take advantage of price swings to buy more units when they are low and fewer when they are high. When the markets are up, you buy fewer units and when the markets are down, the situation is reversed and you purchase a greater number of units per dollar invested. It’s a strategic way to counteract market fluctuations because the Unit Trust knows that you don’t have the time and effort to monitor market movements.

The regular contributions should, over the course of many years, even out the lows of the market and mean nothing more than a footnote in the history of your financial life. Short-term volatility will always be part of the market but to take full advantage of that volatility, it is important to understand that over time, the market always returns to its appropriate level.
Our advice is to turn off the streaming noise from short-term stock-market moves. Even a smooth line looks rough and jagged under a high-powered lens; so too will the price fluctuations of a given stock or sector when inspected using daily or hourly magnification.

Behavioural economists have, in fact, shown that the less frequently you take stock of the value of your investments, the more risk tolerant you become.

Understanding and recognising the causes of volatility can help you take advantage of inevitable market swings, as long as you don’t allow your emotions to dictate your investment decisions. Volatility is one of the most intimidating characteristics of the stock market, but it also presents the most potent opportunity for advantageous investing for those who understand it and have the patience and fortitude to take advantage of it.

Here are three suggestions to mitigate fears about market volatility:

• Take a deep breath before making changes to your portfolio. Refrain from making any investment decisions based on emotion. Tell yourself, “This too shall pass.”
• By holding a broad selection of stocks, bonds, commodities and real estate, the prudent investor is able to ride out market movements in each investment type as they happen. Staying invested over the long term, whatever the cycle is the key to sound, financial health.
• Investing doesn’t require a crystal ball. It relies on a solid, actionable investment plan. Maintain a long-term horizon and ignore the short-term fluctuations.

If you follow these principles, volatility will become your friend instead of your foe.