Strategies for volatile markets

What you’ll learn:

• Keeping the correct perspective of time horizon.
• The importance of rebalancing your portfolio.
• Why holding an investment diary can help.

Volatility measures the size of price movements but not the direction. Higher volatility usually comes with higher levels of investor discomfort. Many investors consider pulling out of falling markets, while those who see a buying opportunity can find it difficult to commit due to fear of mistiming their purchase. Here are three easy strategies investors can adopt.

Strategy 1: Keep the correct perspective of time horizon

When asked how investors know they won’t get caught by another big drop in the markets we give a very honest answer – you don’t! Volatility and short term losses are inevitable and you have to live with them rather than be stifled by them.

Many of us have long-term financial goals, yet we often assess our progress towards them over short horizons. The more frequently you monitor your portfolio, the more risk you will perceive and this sense of greater risk can lead to overly conservative portfolios.

Think about what you would observe if you were to watch the markets very closely. On a second-by-second basis, you will see prices move up and down with no apparent pattern. You would be seeing market risk but not returns. Obviously no personal investor would use such a short time horizon but it does highlight that the more often you look at a portfolio, the more risk you perceive. To manage your stress levels it can be helpful to simply look less often and keep your longer term goals in mind.

Strategy 2: Rebalance your portfolio

The second strategy you can employ would be to rebalance your portfolio. This simple strategy is often neglected during times of stress because it can be emotionally difficult to carry out.

The process of rebalancing means that you will sell assets which have performed well. You then use the proceeds to buy the assets which have performed relatively less well.

It sounds simple, until you have to place the trades. Committing to sell better performing investments at times of turmoil is difficult. It then seems almost illogical to increase exposure to those investments which have been hit hardest and which have been causing you most discomfort. Importantly, rebalancing is an example of good risk management and over time should reap rewards. The challenge is having the discipline to do it.

Strategy 3: Keep an investment diary

By holding an investment at any point in time, you are implicitly expressing that there is no other investment you’d rather be holding. In periods of market turmoil it can be tempting to think that the world has changed and that you need to do something.

Keeping an investment diary is one way that you can help yourself. If you write down the rationale for the investments you make or don’t make, then in times of stress you can read your original rationale and determine whether anything has fundamentally changed – or if it is only your stress levels that have shifted.

The price of an investment can be influenced by many things; the potential for growth and income, or the more emotionally driven sentiment of the market. In periods of volatility, market sentiment can mean that prices are a poor signal of the potential for growth and income. If you were willing to hold an investment at a higher price, seeing the price fall doesn’t necessarily mean that the investment has less potential. Keeping track of your reasons for investing can allow you to reassess whether your original rationale still holds true.

An investment diary can also help avoid getting caught up in late stages of a rising market. Although it is tempting to feel like you are missing out, if something didn’t fit your portfolio at a lower price, it is much less likely to fit your portfolio just because other people are gaining from price rises unless something has changed. Again, reassessing your reasons for not investing can make this a less emotive decision.

Remember that although we all live in the here and now, our investment objectives are rarely realised in the present. Keeping the correct perspective and developing good investment habits will help you be a better investor.

Any investment comes with risk and there's always the chance you'll get back less than you expect, or less than you invest, even if you plan to hold your investments over the long term.