We have seen some quite nasty market falls in 2022 so far. The tech-heavy Nasdaq index is down by nearly 15% from its most recent high, and yields in the bond market have been rising (and prices falling) in anticipation of a gradual ‘tightening’ of policy from the US Federal Reserve and other Central Banks.
In other words, investors expect interest rates to rise and the easy money that has acted as a support to assets over the past couple of years to be gradually withdrawn. Mounting tensions with Russia over Ukraine have also added to the darkening mood.
With huge media attention and minute-by-minute commentary it’s easy to be rattled, but it’s important to keep a clear head.
We would be surprised if authorities overdid the monetary tightening in panic at an inflation overshoot, and while there is a danger of inflation bedding in further, requiring more aggressive tightening, our base case is that prices moderate significantly through the course of this year and that interest rates will stay reasonably low by historic standards. A difficult environment for investors but not, we think, a disastrous one.
In the coming weeks and months, as the inflation picture becomes clearer, we should expect some more big swings in markets as investor sentiment oscillates between fear and hope.
How best to react?
Volatility is an inevitable part of investing; a necessary evil and investors must always be prepared to ride the ups and downs. Keeping everything in cash is the most secure thing to do in the short term but keeping too much in the longer term it is likely to be a poor decision. Inflation could gradually erode its spending power. Through compounding more volatile stock market returns, and ignoring short-term noise, you give yourself a better chance of meeting long-term financial goals.
It’s often the case that the market falls more quickly than it rises, which is psychologically challenging. It’s particularly bad luck if you have just invested a lump sum, but there is consolation from the fact that time spent in the market is far more important than timing the market over long periods, so as long as you have a long term view you shouldn’t be too concerned.
Don’t make changes in haste
Selling out in fear can be the worst thing to do. Large falls can be followed by large rises, so you risk losing on both sides – selling when prices are depressed and not buying in until they have moved higher. Sadly, this is a trap that many investors fall into. Being out of the market also means you are no longer collecting – and potentially reinvesting – any income your investments are paying. In the absence of a crystal ball, keeping invested is often the best strategy, no matter how uncomfortable.
Daily monitoring during a falling market can result in an over-emotional reaction and make rational decisions difficult. If you have a well-diversified portfolio of collective investments such as unit trusts and investment trusts, as well as a strategy you are happy with, then a less regular (for instance monthly) check should be sufficient.
Turning volatility to your advantage
If you have been keeping some cash in reserve, market volatility could be an opportunity to consider investments that you previously thought were too expensive. Often the market overly punishes certain areas as panicking investors sell everything they can. This can present opportunities.
If you are thinking about investing but are nervous of the current conditions, one way to counter market ups and downs, as well as take some of the stress out of investing, is to contribute money at regular intervals, say once a month, rather than a lump sum in one go. The advantage of dripping money into the market is that you don’t need to worry about market timing. The strategy can even turn market volatility to your advantage as you average down if prices fall further. There’s more on this in my article on regular investing here.
Get your plan on track
Sudden market turmoil after a calm period can reveal just how volatile certain investments in your portfolio can be. If this is a shock you weren’t prepared for it may be time to revisit whether you have too much in the most volatile assets. You could add areas to diversify to help smooth out returns, though bear in mind this may dilute the long-term potential of a higher risk portfolio and that any changes should be thoughtful and measured rather than made in haste.
When you invest in the stock market you are buying into stakes in companies. As a shareholder, you participate in the growth of the business if it does well and often receive a share of the profits through dividend payments. Sharing in the profits and growth of companies means your capital is potentially exposed to losses, but over long periods of time history shows that investors often benefit from taking these risks. Striking the right balance between risk and reward is something every investor must consider and revisit periodically – it’s important that you make the most of your money, but without losing sleep over it!
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.