The temptation is to keep everything in cash and not open a newspaper for the next 12 months. However, seasoned investors will recognise that this can mean missing some of the best days in markets, which often come immediately after significant falls. Research from Fidelity shows that missing the best 10 days in markets over the past 15 years would have sliced your annual return from 7.7% to 3.4%*. At the same time, cash rates are still low, often lower than inflation, so there is a significant opportunity cost to remaining in cash.
Acting in haste is often a quick way to lock in losses. In markets such as those we are currently experiencing, it is easy to lock the stable door after the horse has bolted, moving into super-safe areas after markets have already tumbled. This type of ‘insurance’ will always be more expensive at times of volatility. The time to buy it was six months ago.
Volatile markets require a measured response
Instead, look at the balance of your portfolio. Markets have risen steadily for almost a decade and it has been easy to get carried along with certain trends – the dominance of large technology companies for example. At the same time, it has been easy to neglect more ‘boring’ areas such as gilts or property. Balance and diversification are your friends in a difficult climate. Where possible, use market volatility to re-adjust your portfolio to hold a spread of assets appropriate to your longer-term goals.
Remember the value of dividends. Estimates vary, but reinvesting dividends are thought to provide around 60% of the overall return from stock markets. Dividends tend to be less volatile than capital values – companies tend to be reluctant to cut dividends but have less control over their share price. This is particularly true at the moment, when stock markets are being influenced by macroeconomic factors, but company earnings are still robust. You can only receive those dividends if you stay invested. They can help support your portfolio through difficult periods.
It is also a good idea to keep saving regularly. This may be tricky when markets are falling, but each month you will be putting money to work at a lower cost, getting more shares for your investment. The same is true for reinvested dividends. As such, it’s a good long-term strategy, even if it feels like throwing good money after bad in the short-term.
Braver investors could think of the market rout as an opportunity. There may be shares you’ve been looking at for a while but have dismissed as too expensive. Now you can buy them at a cheaper price; a little like a stock market January sale. This is likely to feel uncomfortable, but it is worth remembering that the outlook for China may influence the share price of a small cap UK company in the short-term, but it probably won’t have a lot of influence over its real business prospects. That anomaly is worth exploiting.
Market volatility is unnerving, but it should be a moment to reflect on where you are invested and ask whether you can build a stronger and more robust portfolio. The key, above all, is to stay invested.
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