The volatility in international markets over the last two weeks has had investors scrambling to mitigate losses. Risk appetite is plummeting and together with the collapse of the commodity market, emerging markets have been taking a beating. However, we should all remember to not throw the baby out with the bathwater.
The markets have faced challenges like this before and in light of this, Jim Peters’ 2014 article “Living with Volatility, Again” is particularly illuminating. In his piece, Mr Peters dispenses some sound advice on how to minimise your losses in times of volatility. Below is an edited version of that article.
Volatility is back
Just as many people were starting to think markets only ever move in one direction, the pendulum has swung back the other way. Anxiety is a completely natural response to these events. Acting on those emotions, though, can end up doing us more harm than good.
There are a number of tidy-sounding theories about why markets have suddenly become more volatile. Among the issues frequently splashed across newspaper front pages are global growth fears, policy uncertainty and geopolitical risk.
As to what happens next, no-one knows for sure. That is the nature of risk. Investors in the meantime can protect themselves by diversifying broadly across and within asset classes.
For those still anxious, here are seven simple truths to help you live with volatility:
1.Don’t make presumptions
Remember that markets are unpredictable and do not always react the way the experts predict they will. When central banks relaxed monetary policy during the crisis of 2008-09, many analysts warned of an inflation breakout. If anything, the reverse has been the case with central banks fretting about deflation.
2. Someone is buying
Quitting the equity market when prices are falling is like running away from a sale. While prices have been discounted to reflect higher risk, that’s another way of saying expected returns are higher. And while the media headlines proclaim that “investors are dumping stocks”, remember someone is buying them. Those people are often the long-term investors.
3. Market timing is hard
Recoveries can come just as quickly and just as violently as the prior correction. For instance, in March 2009—when market sentiment was at its worst—the US S&P 500 turned and put in seven consecutive months of gains totalling almost 80 per cent. This is not to predict that a similarly vertically shaped recovery is on the cards every time, but it is a reminder of the dangers for long-term investors of turning paper losses into real ones and paying for the risk without waiting around for the recovery
4. Never forget the power of diversification
While equity markets have turned rocky again, highly-rated government bonds may flourish. This would limit the damage to balanced fund investors. So diversification spreads risk and can lessen the bumps in the road.
5. Markets and economies are different things
The world economy is forever changing and new forces are replacing old ones. This applies both between and within economies. For instance, falling oil prices can be bad for the energy sector, but good for consumers. New economic forces are emerging as global measures of poverty, education and health improve.
6. Nothing lasts forever
Just as smart investors temper their enthusiasm in booms, they keep a reserve of optimism during busts. And just as loading up on risk when prices are high can leave you exposed to a correction, dumping risk altogether when prices are low means you can miss the turn when it comes. As always in life, moderation is a good policy.
7. Discipline is rewarded
The market volatility is worrisome, no doubt. The feelings being generated are completely understandable and familiar to those who have seen this before. But through discipline, diversification and understanding how markets work, the ride can be made bearable. At some point, value re-emerges, risk appetites re-awaken and for those who acknowledged their emotions without acting on them, relief replaces anxiety.
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