Dealing with volatile markets

September 2011, Hawke's Bay Business, Hawke's Bay Today

The media has continued to reference doom and gloom in the share markets, so it’s not surprising investors may be feeling anxious, fearful or even powerless.  These are all natural emotions – after all it’s human nature to try and avoid losses.  
 
We know the markets have had a volatile few weeks, but that’s the way financial markets operate – they have periods of both downward and upward movements.  Whilst you can’t control those ups and downs, there are things you can control - such as ensuring your portfolio is broadly diversified and structured around your tolerance to risk.  Diversification spreads risk and lessens the bumps along the way, making the ride much smoother.  
 
Volatile markets can be an emotional rollercoaster for some investors and being rational in times of adversity can be extremely difficult.  However making financial decisions based on emotions is not wise and one that you may regret later. 
 
Ken French, stock market expert and finance professor at the Tuck School of Business, Dartmouth College offers the following self assessment test as a frame of reference (and not as a prediction of short-term performance).
 
“Ask yourself how you are different from the market,” he said. “If you think you are particularly risk-averse relative to everyone else, then it makes perfect sense for you to sell.  Just don’t get in and repeat the cycle when things look as if they are turning up again.”

“If you think you are more risk-tolerant, then maybe this is an opportunity for you to buy,” he added, noting that the market may pay a small premium to people willing to endure the gyrations. “If you’re not averse to that volatility, you are getting a higher expected return for a modest psychological burden.”

This is depicted in the following image showing an investor’s emotions through a market cycle.  



So before considering any significant changes to your portfolio, take a deep breath and create some distance between impulse and action.  Whilst anxiety and fear are completely natural responses, don’t be tempted to act on those emotions as you can end up doing more harm than good.
 
Remember, nothing lasts forever.  The markets will recover – we just don’t know when that will be.  What we do know is you need to stay invested to benefit from the rebound.  And those investors who acknowledge their emotions, but don’t act on them, will have their anxiety rewarded.  
  
Data Sources:  New York Times 12/08/11 (www.nytimes.com)