Handling volatility as an inexperienced or experienced investor
07 May 2018 | Investment principles
It is sometimes assumed that experienced investors typically have an advantage when it comes to handling a sudden bout of sharp sharemarket volatility.
Certainly, experienced share investors have had to deal with repeated corrections and bull markets that may have taken them by surprise. While these experiences should be an advantage, many investors quickly forget or neglect the lessons from past downturns.
And because experienced investors usually have more at stake, they may be more vulnerable to overreacting to a market downturn than their younger counterparts.
Given the latest gyrations in global and Australian share prices, it's timely to revisit a few long-standing suggestions of smart ways to handle higher market volatility.
1. Buy a pair of noise-cancelling headphones (figuratively speaking)
Block out the "noise." Don't overreact to daily media commentary and news reports on daily market movements; and try to ignore short-term fluctuations in share prices. A recent New York Times article – So it's your first market hiccup. What should you do? – veteran personal financial journalist Ron Lieber suggests investors ask themselves: Is the stream of news useful? "Those talking heads know nothing about you and why you invested in the first place," Lieber comments. "So, don't base your actions of their pontificating and pronouncements."
And a recent Vanguard research report, How to navigate market corrections, aptly illustrated with a pair of noise-cancelling headphones, warns about the dangers of repeatedly checking the gyrating value of your shares. "Making a decision based on a recent market event usually results in a mistake," it cautions.
2. Don't treat a sharp market downturn as a rare event
Investors can expect to face many downturns in their investing lifetime. "Knee-jerk reactions in this market environment can lead to costly mistakes," the Vanguard report stresses. "Dramatic [paper] losses can sting but it's important to keep a long-term perspective." The sale of shares after a price fall locks in a loss, preventing an investor benefiting from a subsequent market upturn.
Global share prices have had 11 corrections (declines of 10 per cent or more) and eight bear markets (declines of 20 per cent or more, lasting at least two months) between January 1980 and February this year.
In those last 38 years, global investors have had to deal with Black Tuesday in 1987 (Black Monday in the US due to time difference) when global sharemarkets crashed, the tech boom/bust and the GFC. Yet investors who had stuck to appropriate long-term asset allocations and reinvested their dividends where possible would be well ahead today.
3. Remember time is probably on your side
In most cases, your intention is to create long-term wealth. So, remain focussed on the long haul without being distracted by day-to-day market movements or any short-term setback. Young investors truly have time on their side and recent retirees, for instance, can expect many investing years ahead.
4. Don't try to time the market
Keep in mind that volatility works both ways – up and down, as reinforced by market movements over recent months. Unfortunately, these gyrations present a temptation to try to time the market. Even investment professionals rarely succeed in consistently picking the best times to sell or buy.
Investors can readily recognise the futility and difficulty of trying to time the market by looking at how the best and worst trading days have occurred closely together. Between December 31, 1979, and January 31, 2018, 12 of the 20 best trading days on the S&P 500 index of US shares occurred in years with negative annual returns. Further, nine of the 20 worst trading days occurred in years with positive annual returns.
Rather than trying to time the market, consider the benefits of a dollar-cost-averaging strategy. Dollar-cost averaging simply involves investing the same amount of money into, say, shares or broadly-diversified managed funds at regular intervals over a long period – whether market prices are up or down.
The principal benefit of dollar-cost averaging is not the price paid; it is the following of a disciplined, non-emotional approach to investing that is not distracted by market sentiment. (See Dollar-cost averaging: An investor's emotional circuit breaker, Smart Investing, April 16.)
5. Think about creating a volatility 'bucket' if retired or nearing retirement
This strategy involves setting aside one to two years of living expenses if possible in a cash "bucket", depending on an investor's circumstances. The aim is to try to avoid having to shares during a market downturn to provide retirement income. (See A retiree's volatility 'bucket', Smart Investing, February 16.)
6. Never overlook that sharemarket returns are much more than capital gains
While your share prices will keep fluctuating, your dividends will keep flowing from a well-diversified share portfolio. Historically, dividends have made up a large proportion of the total returns from Australian shares.
Written by Robin Bowerman, Head of Corporate Affairs at Vanguard.
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Robin Bowerman, Head of Corporate Affairs at Vanguard Australia, shares investment and personal finance insights gained from over two decades in the finance industry as writer, commentator and editor.