Financial markets periodically suffer from sharp and sudden declines, most recently during the 2020 COVID-19 pandemic. Put simply, volatility can be defined as the fluctuation in the prices of investments. This leaves many investors understandably concerned. My contribution will aim to provide perspective and focus on this scenario.
Market corrections are a natural part of the investment journey and it is important to remember that volatility is to be expected from time to time. One might ask, but what creates these price fluctuations (or market volatility)? Market volatility can be driven by the influence of economic data releases, geopolitical and special events, as well as investor sentiment, at any given time.
Market volatility can cause investors distress; however, it is during these periods when it is most important to remain calm. Rather than focusing on the market downturn, investors should keep their focus on why they invested in the first place. Be it for the potential of better returns, one’s retirement plan or to manage wealth, it is essential to maintain the focus on your long-term original investment plan.
While volatility can be painful for investors, it also creates investment opportunities. When investor sentiment is negative, the prices of investments are driven down well below their true value. This provides an opportunity for investors to buy into the market at lower prices, with the potential for better returns in the long run.
The million-dollar question would be: to what extent should one stay invested amid market volatility? History does not necessarily repeat itself and markets do not always follow the same recovery paths, but lessons are learnt from prior experiences. History shows that financial markets go up in the long run despite short-term fluctuations.
Periods when ‘everyone’ is overwhelmingly negative often turn out to be one of the best times to invest
When investors overreact to market conditions, they may miss out some of the best performing days. While no one can predict exact market movements, periods when ‘everyone’ is overwhelmingly negative often turn out to be one of the best times to invest.
The strongest market performance is frequently seen directly after the largest downturns − 2020 was an exemplar case study of such behaviour. It is natural that when markets destabilise, it becomes tempting for investors to exit in order to avoid losses.
However, for those investors able to rise above chaos and take a longer-term view, it may well be an ideal buying opportunity. Investors giving in to the unsettling circumstances and selling may mean they would be forfeiting the opportunity to benefit from any sudden market comeback, potentially crystallising a loss.
Ultimately, staying invested for longer periods tends to offer higher return potential because long-term investing increases the chance of positive returns. It is, therefore, important to stay focused.
For investors concerned about market downturns, the key is to diversify. Different asset classes tend to perform differently under various market conditions due to their unique characteristics or relationships. By combining assets with different characteristics, the risks and performance of different investments are combined, thus lowering overall portfolio risk. That means, a loss in one asset class may be compensated by a gain in another. It is important that your investment portfolio is kept aligned to your current lifecycle stage, attitude to risk and goals. This is why regularly reviewing your investment portfolio with your trusted financial planning adviser is of paramount importance.
Adopting a regular investment strategy can also help. Investing regularly means continuous investment, regardless of what is happening in the markets. When investors make fixed regular investments, the price at which units are bought averages out, which in turn will smooth out the investment journey. The outcome of such strategy can address some of the worry of sudden drops in the market or buying when prices may seem too expensive.
On a final note, investors must not let short-term market fluctuations take over their feelings and dictate their long-term ambitions. Ask yourself whether there have been any significant changes to your personal circumstances, investment objective and risk profile to warrant a review of your original investment plan. If so, reach out to your trusted financial adviser to guide you.
Short-term market volatility creates uncertainty. With uncertainty comes opportunity.
Konrad Borg Myatt, CEO, HSBC Global Asset Management (Malta) Ltd
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