Start investing: 5 Tips to Handle Market Volatility
11 Feb 2023
In today’s digitally connected world, short-term market volatility can be more prevalent thanks to the immense amount of information at one’s fingertips. When dramatic sell-offs happen, it can be upsetting especially in the face of sensational headlines and negative media coverage, often challenging investors’ commitments to their long-term investment plans.
Now that we are arguably in the later stage of the business cycle, further periods of volatility may lie ahead. While there is no fool-proof method to navigate market ups and downs, the following tips can help.
Short-term volatility is part and parcel of the investment journey
Markets can fluctuate depending on the news flow or expectations on valuations and corporate earnings. It is important to remember that volatility is to be expected from time to time in financial markets.
History does not necessarily repeat itself, but it does rhyme. Short-term volatility can occur at any time, but they do not necessarily derail the long-term growth in stock markets. Historically, significant recoveries occur following major setbacks including economic downturns and geopolitical events (Chart 1).
While headline-grabbing news can affect short-term market sentiment and lead to reductions in asset valuations, share prices should ultimately be driven by fundamentals over the long run. Therefore, investors should avoid panic selling during volatile periods, to avoid missing out any potential market recovery.
Chart 1: Returns from $10,000 invested in global stocks over the last 2 decades
Long-term investing increases the chance of positive returns
When markets get rocky, it is tempting to exit the market to avoid further losses. However, those who focus on short-term market volatility may end up buying high and selling low. History has shown that financial markets go up in the long run despite short-term fluctuations (Chart 2).
Though markets do not always follow the same recovery paths, periods after corrections are often critical times to be exposed to the markets. Staying invested for longer periods tends to offer higher return potential.
Chart 2: The performance range of global equities over different time frames
Diversification can help achieve a smoother ride
Diversification basically means ‘don’t put all your eggs in one basket’. Different asset classes often perform differently under various market conditions (Chart 3).
By combining assets with different characteristics, the risks and performance of different investments are combined, thus lowering overall portfolio risk. That means, a lower return in one type of asset may be compensated by a gain in another.
Chart 3: The performance of each asset class varies over time
Market downturns may create opportunities
Don’t be passive in the face of market declines. When market sentiment is low, valuations tend to be driven down which provides investment opportunities (Chart 4). In rising markets, people tend to invest as they chase returns, while in declining markets people tend to sell. When investors overreact to market conditions, they may miss out some of the best-performing days.
Though no one can predict market movements, the times when ‘everyone’ is overwhelmingly negative often turns out to be the best times to invest.
Chart 4: Global equities trade cheaper during economic crises
Investing regularly means continuous investment regardless of what is happening in the markets.
When investors make fixed regular investments, they buy more units when prices are low and less when prices are high. This will smooth out the investment journey and average out the price at which units are bought (Chart 5). It thus reduces the risk of investing a lump sum at the wrong time, particularly amid market volatility.
The longer the time frame for investment the better, because it allows more time for investments to grow (the compounding effect).
Chart 5: Dollar-cost averaging helps smooth the effects of market movements
The chart shows what happens to USD1,000 invested monthly vs a lump-sum investment of USD12,000. After a year, the total amount invested is the same, but the total shares purchased and the cumulative value are higher for monthly regular investment (dollar-cost averaging). Average cost per share for dollar-cost averaging is cheaper than lump-sum investment (USD0.90 vs USD1.00) in this hypothetical example. Please note that dollar-cost averaging may not always outperform lump-sum investment.
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