Market volatility is an inevitable part of investing and therefore it is important that investors arm themselves with the right tools to reduce the impact of market fluctuations on their portfolios. The following article will outline some tips and tricks that you can implement to help you maximise your returns over the long run.
What is market volatility?
Market volatility refers to the statistical measure of the dispersion of returns for a given security or market index. What this is really talking about is price fluctuation that may occur over a short period of time. This means that your portfolio may experience sharp rises and drops over a short window of time which means the value of your assets or individual holdings are increasing and decreasing. If a market has experienced large swings, both positive and negative, this is what investors consider to be volatile. The degree of volatility of a particular asset can often impact its price and ability to produce returns.
Highly volatile assets such as shares are riskier, however, as they are growth assets they have a greater ability to produce returns over the long-term. This is what is meant by the ‘greater the risk, the greater the reward.’ Conversely, fixed-income assets are associated with considerably less risk and therefore do not generate as favourable returns for investors. It is important to consider the level of risk you wish to take on prior to investing as they will impact the range of asset classes you choose to hold.
How can I reduce volatility?
One of the main ways to reduce the impact of volatility on your portfolio is investing over a long-term timeframe. As risk is measured in time, the shorter an investment timeframe the riskier it is likely to be and vice versa. Thus, it is important that investors adopt a long-term mindset as one month, one year or even a few years is considered a blip in a long-term investment strategy.
Although short-term declines in the value of your investments may cause you to rethink this strategy, it is critical that investors do not make decisions based on short-term performance. This is likely to result in investors selling when their investments have decreased in value and therefore realising a loss. However, taking a long-term approach and holding these investments during market downturns will enable these assets to recover and therefore generate returns in the future. To read more about the benefit of long-term investing, please click here.
Another way to reduce the impact of market fluctuations is to invest often, both when the market is high and low. This approach is called dollar-cost averaging and refers to investing capital in smaller, fixed amounts on a regular basis over a longer period of time instead of in one lump sum. Although the price of the particular asset you are investing in may increase or decrease, the risk of paying a higher price is reduced whilst you maximise your chances of paying a lower average price.
Timing the market
This strategy is linked to dollar-cost averaging and occurs when investors try to buy at the bottom of the market and sell at the very top. Although this has the potential to maximise your returns, it is very difficult to get it consistently right, even for the most experienced investors. Therefore, it is a good idea to somewhat monitor market conditions to help you to buy in and sell out at appropriate times, however, constantly trying to time the market is likely to result in investors missing opportunities. To read more about timing the market, please click here.
Diversification is an important risk management strategy which is basically what investors call ‘not putting all your eggs in one basket.’ This entails holding a range of investments from both assertive and defensive asset classes, across different sectors, in both domestic and international markets. This will help to reduce the effect of volatility on your portfolio as particular holdings may be more impacted by market downturn compared to others, and therefore having a wide range of investments should be a consideration for all investors.
Speak with a professional
Another way to maximise your portfolio performance over the long-term and gain an advantage over other investors, is to engage with a financial adviser who has the expertise, experience, and research to help reduce the impact of volatility on your portfolio. Financial advisers can also help you to remain disciplined and make decisions based on the emotions you may experience during market volatility which can cause investors to sell at inopportune times and lose profits as a result.
If you would like tailored assistance with your investment strategy or would like to ask questions about market volatility and your portfolio, please click here to organise a complimentary 20-minute consultation with an EPG Wealth Senior adviser.