Market volatility and investment strategy

What is market volatility?

The stock market experiences continual fluctuations as share (equities) and bond (fixed interest) values move up and down over time.

However, occasionally the market can experience more extreme and frequent fluctuations over a short period of time, this is generally referred to as ‘market volatility’.

For a long-term investor, volatility is inevitable and to be expected in all but the most low-risk portfolios.

What causes market volatility?

Market volatility is often the result of a short-term uncertainty.

For instance, there could be an unexpected imbalance between supply and demand which causes company profits and, therefore, security about the availability of a product to fluctuate. When availability is very high, and demand is very low, share prices can fall dramatically. This situation can arise from a sell-off, where shareholders lose confidence in their investments and try to sell their holdings. Unwanted shares look unattractive to potential buyers, and so prices continue to decline.

A sell-off can also be triggered by events that impact the stock market as a whole or an industry sector, rather than just a specific company. These events could be natural, such as drought or earthquake; political, like war or revolution; or economic, like recession or inflation. Sell-off behaviour is frequently a knee-jerk reaction to unexpected changes in one or more of these areas.

For example, as a result of the Covid-19 pandemic the stock market experienced volatile downward movement in March 2020. Worldwide, stock markets lost over 20% of their value in a period of just 12 days.

Market volatility isn’t always a downward trend, there are examples of where share prices have dramatically increased in a very short period of time.

This is something that can happen at a company level, such as particularly strong sales of a new product or more widely, for example where the first Covid-19 vaccine test results were successful.

What should investors do in market volatility?

Often, investors don’t need to do anything.

A holder of a share in a hospitality company at the time of the Covid-19 outbreak could have sold their shares for a low price. However, many of those shares, which had once been worth so little, have recovered their value.

With this example, we have the benefit of hindsight, but as a rule of thumb it’s best not to react impulsively to market volatility. Long-term investment is about averages. Riding out a series of volatile events in the stock market is more likely to yield overall growth in a diversified investment portfolio than reacting to every positive or negative fluctuation.

Timing the market can be incredibly complicated, with even the most seasoned investors getting it wrong. Attempting to sell stocks high, to re-enter the market when they are low, may well produce lower returns than riding out the fluctuations by keeping your investments in place.

It’s important that long-term investors are able to take their emotion out of the situation and focus on the long-term goals, rather than the current market fluctuations.

How can you feel more in control during times of market volatility?

Utilise the experience of a financial adviser

A financial adviser will help you to match your investments to your goals, your tolerance to risk, and the amount of money you have to invest.

As part of an assessment, our financial advisers would look at your liquidity needs over the predicted lifetime of your investments and the diversity of your portfolio. This can help you to ride out market volatility by ensuring you have enough funds available to be able to stay invested long term, along with ensuring your portfolio is sufficiently diverse to minimise any losses during a downturn.

Our financial advisers will also be able to provide you with the confidence you need if you’re feeling unnerved by market volatility. Financial advisers carefully map out your investment portfolio against all of your other finances, taking into account volatility, the latest research and historical perspectives, and they’ll be able to show you the evidence you need to bolster your faith in times of uncertainty.

Diversify and rebalance your portfolio

Is it time to revisit your investment portfolio against your appetite for risk to ensure they are still aligned? Have your goals changed? For example, are you looking to make more sustainable investments?

An investment portfolio’s diversification can change over time as some investments grow and some decline. By revisiting the holdings you are invested in, you can ensure that your portfolio reflects your goals and appetite for risk.

If responsible investing is important to you, then it could be worth considering investment strategies that incorporate environmental, social and governance (ESG) criteria. We can help you identify companies whose values are aligned with your own and at a level of risk that you are comfortable with.

Set a financial strategy and stick with it

Impulsive reactions to market volatility are based on our emotions. Having a long-term goal in mind from the outset will help you to focus on what you’re trying to achieve and to feel comfortable with the market fluctuations.

The value of investments and any income from them can go down as well as up and you might not get back the original amount invested. The past is not a guide to the future.