Strategies to Reduce Anxiety When Investing in Shares

August 2011, Hawkes Bay Business

Many investors experience various levels of anxiety when financial markets are volatile.  The doom and gloom in the media can further increase this apprehension therefore it’s important to put some context around the market movements and recent falls.
 
Earlier this month, ratings agency Standard & Poor’s, downgraded the credit rating for the United States to AA+, the equivalent of Belgium and New Zealand.  Two other ratings agencies still rate the United States at AAA.  This change in ratings fuelled further nervousness in the markets causing some investors to panic and instigate a sell down of their shares which resulted in markets falling world wide.
 
Although the New Zealand share market (NZX50) fell by 3% on 5^th August 2011 in anticipation of the change, this was the first significant fall since the Global Financial Crisis (GFC) of 2008 where the NZX50 fell 3% or more in the months of September and October.  When the markets reopened on 8^th August, although there was a further fall of 2.8% in response to the ratings downgrade, the markets have been less volatile since, with small positive gains occurring between 10^th and 26^th August (the time this article was prepared).
 
No one is disputing the GFC wasn’t a significant financial event, however we don’t think anyone anticipated the subsequent recovery was going to be without any bumps along the way.  Reacting to these events in isolation is inconsistent with long term strategic planning and not recommended. 
 
We don’t envisage there will ever be a time when ‘all is well’ in the global economy or that you can invest in share markets with minimal volatility.  If there was no risk, the expected return of shares would effectively be the same as government bonds. Simply, there is a ‘risk premium’ that investors expect to receive for investing in shares.
 
Nevertheless, investors do experience various levels of anxiety in volatile markets and staying focused on long term strategies can be difficult.  However there are strategies your financial adviser should adopt to minimise psychological stress and increase the probability of you still achieving your long term objectives. 
 
These include:
 
• Asset Allocation – Ensure your asset allocation is appropriate to your individual circumstances and goals.  Growth assets are more volatile than defensive assets, so if your investment timeframe cannot withstand the current share market volatility then changes should be made.
 
• Diversification – It is impossible to predict how markets or particular asset classes will perform at any point in time, which makes diversification essential.  This spreads your risk and increases the potential for capturing return. 
 
• Stay Disciplined – Often it can be quite painful to remain disciplined during difficult times, but it’s imperative not to undermine your sound financial strategy due to short term events.  Many investors have learnt the hard way the perils of chopping and changing their strategies based on short term market movements. 
 
• Fixed Interest Strategy – The primary objective of fixed interest assets is to protect capital and provide a volatility dampener for your growth assets portfolio.  In other words, it’s about managing and understanding risk.  Fixed interest should never be used to drive investment returns – this is the role of property and shares, where the assumption of greater risk is compensated with higher expected returns.
 
• Market Timing Is Rarely Successful – Stock markets anticipate information, so the ‘doom and gloom’ is likely to be already priced into the stock market.  Selling to avoid further losses is unlikely to be successful, as you will realise short term losses and be ‘out of your seat’ when the market rebound occurs.
 
• Markets Often Rebound – Following periods of aggressive sell downs, history shows that markets often rebound quite strongly.  
 
• Risk & Reward – Markets don't always get pricing right in the short term. That's the nature of risk. However academic research shows that over the long term risk and return are related, so the more risk you take the higher the anticipated return will be.
 
In Summary
It’s the nature of markets to go both up and down, and returns are variable.  If you have realistic expectations, remain diversified and have a disciplined and focused approach, you maximise your changes of a successful investment experience - even during volatile times.