Volatility is a given in the investment world, and in the past year investors have been exposed to several events that sparked short-term volatility. There were irregularities around corporate finances, sovereign events like the ANC elective conference, and concerns around rising inflation in the United States, which led to a sharp decline in US markets earlier this year. When the headlines look bleak, many investors become excessively pessimistic and reactionary. This can be more detrimental to long term wealth creation than the volatility that sparked it in the first place. Here are the four best investment lessons we learn from volatility:
- Volatility brings risks – but also rewards
In equity markets, volatility is inevitable. Consider it the ‘nature of the beast.’ Unfortunately, many people panic at the first sign of market corrections. This is usually when wealth managers receive frantic calls from their clients, because the value of their investments has suddenly decreased. What many investors lose sight of in times of uncertainty and sharp corrections is the fact that this volatility provides investors with opportunities to access markets at lower prices.
- Despite this short-term volatility, equities have the highest potential to create wealth
Equities have proved time and time again that as an asset class they deliver the highest returns over the long term. It is a risky asset class, however, with the potential for large losses in capital over the short term, so the duration of your investment is crucial. The inherent risks are reduced and eventually negated if your investment horizon is longer than five years. If you can’t commit to five years – and preferably longer – equities probably aren’t the right investment for you.
- The biggest threat to your wealth-creation efforts is… you!
The inherent fear of losing money drives many investors to make poor decisions. Research shows that we feel the pain of losses far more acutely than we enjoy gains. This is referred to as loss aversion, and it’s the reason why investors are more likely to make irrational decisions based on losses than they are to be reckless with gains. Emotions related to losses weigh so heavily on some investors that they would rather sell-off their equity investments, thereby locking in the losses permanently, than stay invested and risk further losses during an uncertain period.
- Use volatility as an opportunity to ensure your portfolio is still correctly positioned
A hands-off approach to your investments can be healthy in volatile times, but don’t be so passive that you miss out on necessary tweaks and updates. Corrections often prompt market participants to perform sanity checks, which is very healthy. Sometimes periods of volatility will bring to light shortcomings in your overall investment strategy or portfolio construction. This can be a necessary prompt to reconsider whether your current position is still best suited to your needs. A plan that was put in place 10 years ago may well need to be adjusted and rebalanced. This is also a good time to check that your portfolio is appropriately diversified, given that diversification is one of the best ways to mitigate the risks inherent in equity investments.Volatility is very much a feature of investment markets and we know that there will be many more bouts of market turbulence in the future. The best investors not only stay the course in the face of uncertainty, but go one step further and capitalise on the opportunities presented by those who are selling off out of fear. You’ll only get to know your investor-self and your true appetite for risk during volatile periods – and the challenge is to make sure you don’t make any fear-driven moves that will undermine your long-term wealth creation efforts. Remember: It’s not so much the market that matters – but your reaction to it.
AUTHOR: Adriaan Pask, CIO at PSG Wealth