Volatility toolkit: how to deal with market zigzags

The value of your investments and the income you receive from them can go up and down, and you may get back less than you invest. Any examples are for illustration purposes only.

If you’ve cut your teeth as an investor, or even if you’re a newcomer who has seen a few share price charts, you’ll know that stocks move. It’s what they do. Sometimes they’ll pootle along, sometimes the journey gets bumpier. It’s volatility in action and it’s not the enemy of investing, it’s part of the package. While it can be a bit unnerving to see prices change, learning how to live with volatility, and possibly even use it to your advantage, is part and parcel of every good investor’s journey.

In short, stocks move because the world moves. A company’s latest earnings announcement, a change in a country’s interest rate, even a tweet - push and pull factors are always at play, with investors around the world interpreting them and influencing how much they think a stock (and the company underneath it) is worth.

Sprinkle in a bit of our own behavioural biases, the misreading of a situation or outright overreaction, and it starts to make sense why markets are constantly moving.

When it comes to the stocks themselves, you might notice that some have jumpier journeys than others. That could be because a firm has promised big things and garnered a lot of support, with lots of room for disappointment if it doesn’t deliver. Compare that to a company consistently producing near-identical levels of cash year after year. The sense of stability and outlook for each company are different and will naturally mean investors treat them distinctly. Where companies’ fortunes look less certain, often volatility will rise compared to those able to show evidence of relatively predictable earnings streams, albeit with potentially less of an exciting future.

If you leave it until the waves get choppy to think about your volatility action plan, you’ll be fighting your own biases and emotions as much as the market. Do your future self a favour and figure out how to respond while waters are calmer.

Have a plan: Together with your time horizon and financial goals, the level of portfolio volatility you’re prepared to put up with will help you decide which assets to choose. Remember, your overall asset mix is a huge determining factor in your pursuit of returns and that blend of stocks, bonds, commodities etc. should reflect your needs. What happens from now until your time horizon starts looming shouldn’t matter, but if it does, make sure your portfolio reflects that too. Psychologically, though, prepare yourself for rough patches. They happen and are par for the course.

Volatility is the price we pay for the hopeful long-term outperformance of equities over cash.

Diversify: Your broad blend of assets is one thing but how is each of those buckets set up to deal with volatility? Is the stocks portion full of one sector or industry? That could mean big movements if the same outside influence hits the same group of companies. Think about spreading risk across sectors, geographies and company sizes.

Set expectations: This one’s more about you than the markets. We all get wide-eyed at bigger market movements than we’re used to, so plan for it. Keep your reasons for investing in your stocks close and refer to them if the charts start to jump around. Has anything material changed or are they getting swept along with the tide? If the fundamentals look the same, there’s often no reason to make wholesale portfolio changes in the heat of the moment.

On that note, don’t try to fight your feelings, harness them instead. Loss aversion affects us all enough to make a loss hurt twice as much as the joy of a gain. That can mean we want to rush into cash and stunt the long-term story instead of just accepting volatility and taking a breath.

Zoom out and look at the bigger picture - is this a short-term influence or is it time to sell up and move on? None of this should be done rashly, so rely on your cooler head’s preparation and take a second to remind yourself that it will eventually pass. Recency bias can make us think the bad times will last forever. History shows us they don’t.

It’s amazing how we can get dragged into panicking by the headlines, newsflashes and other investors losing their heads. Misery loves company, and all that. Don’t fall into the herd mentality by keeping your own research to hand and remembering your own preparation. The more prepped you are, the less you should feel the need to bemoan the market.

For long-term investors, often the best course of action during a bout of volatility is to do nothing. Not every blip is meaningless to every company though. If you’re looking down at your reasons for buying a stock and it suddenly looks very different in real life, your thesis may be worth revisiting. In this case, selling may be prudent but make sure research is driving the decision, not fear.

Animal spirits can mean even the nice stocks get arrested when the market party is raided. If you see quality companies hit through contagion, or you think a market selloff is over the top, a bout of volatility might actually throw up some decent buying opportunities for any cash you have on the sidelines. This isn’t about snapping up any old rubbish though. Keep your standards high and look for discounts where the fear is obscuring solid business fundamentals.

An inexperienced investor might be scared by volatility and think it’s a sign the market is broken. For the cooler heads, it’s the part of the whole endeavour that can help us spot mispricings and re-examine our investment theses. Perspective comes with preparation though, and not having to worry about your portfolio in times of turbulence is key. Make sure both your portfolio and your head are prepared for whatever comes next. And if nothing has really changed, it might just be an occasion to step away and do nothing.

Important information

When investing, your capital is at risk. The value of your investments, and the income you receive from them, can go down as well as up and you may get back less than you invest. Forecasts aren’t a reliable guide to future results or returns.

Make sure to do your own research on what investments are right for you before investing or consider seeking expert financial advice. Please note that this article is meant for information and does not constitute any financial advice. This is not an offer, recommendation, inducement or invitation to buy, sell, or hold any securities, or to engage in any investment activity or strategy.