Stuff happens. Complex instruments designed to package up and take the risk out of subprime mortgages blow up in the face of the banking industry. The world’s fifth largest economy votes to leave the European Union. A newly elected president raises tariffs (or threatens to) on goods coming from his country’s biggest trading partners. Attacks on oil tankers in the Straits of Hormuz send oil prices higher. It all adds to a sense of market volatility that places a question mark over investment strategy.
Every time something major happens, markets naturally respond – either in a sudden spasm or in a longer-term movement higher or lower. For instance, in the wake of the great financial crisis, the Dow Jones industrial average plummeted 777 points in a single day – September 29, 2008, to be precise – when the US Congress rejected legislation to bail out stricken banks.
Shares, bonds and currencies, in particular, seem most sensitive to the impact of events in the wider world, but an economic shock, such as Britain crashing out of the European Exchange Rate mechanism can also affect assets such as property. And of course, thanks to the “animal spirits” of traders or glitches in trading algorithms, the share markets are quite capable of going into sharp reverse for no good reason at all.
All of which is the source of nightmares for some investors. Well, perhaps that’s not a good way of putting it. Long sleepless nights make nightmares an unlikely scenario.
But here’s the important thing to remember. Just as “stuff happens,” volatility in the markets is a fact of life. The question for investors is how to respond to short or longer-term market moves and corrections.
A Cause for Panic?
Volatility in a market is not necessarily a negative thing. By definition, a volatile market is characterised by sharp fluctuations in the value of assets. In that respect, the price of shares can rise sharply as well as fall. That can be good news for active traders. And of course, if prices fall there are buying opportunities.
But a volatile market is also a riskier market. A sharp rise today could be followed by a steep fall in values tomorrow. When the feeling takes hold that the fall is to continue, then what you get is a kind of self-fulfilling prophecy. Traders respond to fears that the market will fall further by selling, so the market falls further.
That’s a scary prospect, but it’s always wise to remember that for long term investors, winter doesn’t last forever. A decade after the financial crisis, US stocks are at record highs. The truth is that over the longer term, the major stock markets have delivered growth.
But that’s not to say that the issue of volatility should be ignored. Everyone with significant sums invested should keep a weather eye on the direction of markets and, when necessary, take action to protect wealth.
Wealth managers have a significant role to play.
The Immediate Impact
High volatility in the markets can be a particular problem for those who – for whatever reason – can’t afford to sustain short term losses.
To take an example, if an individual has built up a substantial pension pot that is largely invested in shares, a downturn in the market that coincides with a planned retirement date could greatly affect his or her income once retired. And the issue doesn’t simply affect those who plan to purchase an annuity. A protracted downturn reduces the sum available to turn into cash or direct to other investments. Indeed, anyone who has a requirement to access a certain amount of money within a clearly defined timeframe can be hit hard by a falling market.
The Importance of Planning
So it is important to plan. The starting point for any investor is to define clear financial and life objectives that will, in turn, define investment strategy.
Traditionally this has been seen in terms of appetite for risk. Thus someone with a low appetite for risk might avoid markets that are – in the opinion of the wealth manager or adviser – likely to be volatile.
But it’s arguably better to think in terms of goals and the kind of investment strategy required to deliver on them. For instance, if the goal is to retire – or begin a winding down process – at 50, then you can build a financial strategy around that. The same might be true if a goal is to move out of the city and buy a spacious home surrounded by five acres of land in the countryside. Again, this is the kind of goal that a sudden fall in the value of investments could run a coach and horses through.
So at some stage, the priority of an investor might change from high return/higher risk investments and towards a strategy designed to preserve wealth. This might be true against any economic or market backdrop, but it also important to chart the changing risks associated with a range of asset classes.
Ideally then, one of the best ways to manage volatility is to conduct regular financial reviews to ensure a) that existing investments are performing well and b) that they are aligned to life objectives. Such reviews provide an opportunity to look again at asset allocation across the portfolio in response to events.
The Route – City wealth club understands that financial planning must respond not only to changing life goals but also to trends and sudden changes within asset classes. To that end, all Members are offered two financial reviews every year.
The Route would not advise investors to panic in the face of volatility – there may be no need to do so – but instead take careful and considered decisions as part of a process of regular reviews.
To find out more about Membership, please call: 020 3141 9040
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