Handling volatility

It is sometimes assumed that experienced investors typically have an advantage when it comes to handling a sudden bout of sharp share market 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.

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? – 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 share markets 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 focused 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.

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 sell shares during a market downturn to provide retirement income.

6. Never overlook that share market 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.

If you need further discussion or assistance on this topic please contact us on 08 8232 9498.

Source : Vanguard May 2018   Written by Robin Bowerman, Head of Corporate Affairs at Vanguard.

Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS Licence 227263) is the product issuer. We have not taken yours and your clients’ circumstances into account when preparing this material so it may not be applicable to the particular situation you are considering. You should consider your circumstances and our Product Disclosure Statement (PDS) or Prospectus before making any investment decision. You can access our PDS or Prospectus online or by calling us. This material was prepared in good faith and we accept no liability for any errors or omissions. Past performance is not an indication of future performance.

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