Most people associate market volatility with risk, but there is more to understand when it comes to investing and volatility. When answering the question ‘what is market volatility?’ it’s important to not only explain volatility but look at how to interpret volatile markets too.
Volatility is the rate at which the price of a stock fluctuates over a particular period, and you will see this in a stock chart with the peaks and troughs. With high levels of volatility, you may see an increase in sudden, and sharp peaks and troughs. With low levels of market volatility, you might see a smoother stock chart.
Volatility can describe when a particular stock or market experiences periods of unpredictable, and sometimes sharp, price movements.
Interpreting this comes down to perspective. It could suggest risk, but it could also suggest opportunity. When markets are down, meaning a stock has decreased in value, it could be a good buying opportunity as you will get more stock units for your money. Whilst volatility has negative connotations, it is important to remember that volatility can also refer to sudden price rises as well as dips. In volatile environments you could also see your investment value go up suddenly.
What affects market volatility?
Several factors can affect volatility levels, such as central bank decisions and geopolitical events. For example, when UK interest rates change, or when the UK Government announces a major policy change, you may see this reflected in the FTSE 100 index (the stock prices of the 100 largest companies on the London Stock Exchange).
Volatility is a normal part of long-term investing, even when it can feel uncomfortable to see prices falling. Remembering that this is a normal part of market cycles could help you stay calm. By setting a goal you should be able to focus on a long-term vision, and not be blown off course by occasional dips.
The lockdown of March 2020 was a good example of this. Markets dipped suddenly, but the only way you would have lost money is if you withdrew your investment to cash. Those who stayed invested saw the marker recover and, in the US, new record highs were set by the end of that year. Keep in mind that past performance isn’t a guide to future performance, but this illustrates a point on volatility, and the benefits of taking a long-term mindset over short-term emotional reactions.
Indeed, that example illustrates how volatility can also represent opportunity. Those who invested during the dip were able to buy at the lower price, benefiting from this when markets then recovered. This comes back to attitude to risk and investor mentality and psychology. Rather than running to cash, some investors put more money in. As renowned investor Warren Buffet famously said, “Be fearful when others are greedy and be greedy when others are fearful.”
Additionally, keeping your money invested over a long period of time can help to smooth out the effects of volatility on your investments.
The art of diversification
At True Potential, we believe diversification is the best approach to protect yourself from volatility. In simple terms, diversifying your investments means spreading your money across different asset classes, locations and strategies. The reason this is effective is because if one market is experiencing high levels of volatility, for example, Asian markets, but the European markets are performing well, then this will balance out the volatility and prevent your investments from dropping.
So, what is market volatility?
Market volatility is a normal part of investing and illustrates the importance of starting out with a long-term goal. Ask yourself three questions:
- What is it you are investing for?
- How long will you need to invest for?
- What level of risk are you comfortable taking?
Once you know the answer to these questions, you can then chart your course with a long-term perspective. You should invest for a minimum of five years, giving time to ride out any fluctuations in the market.
Your choice of attitude to risk when choosing an investment is also an important consideration. At True Potential, our Portfolios are ranked on a Defensive to Aggressive scale, with an attitude to risk survey helping to determine which Portfolio is right for you. A Defensive Portfolio aims to be less volatile than an Aggressive Portfolio but in doing so offers fewer opportunities for growth and vice versa.
As with any investment, it could be worth seeking financial advice if you aren’t sure or if you have specific concerns around market volatility.
True Potential Wealth Management offers restricted financial advice. Our service is specifically designed for clients wishing to access their financial affairs online. With investing your capital is at risk. Investments can fluctuate in value and you could get back less than you invest. Tax rules can change at any time. Please be aware that this communication should not be considered as financial advice.
True Potential Wealth Management LLP is authorised and regulated by the Financial Conduct Authority. FNR Number 529810. Registered Head Office: Newburn House, Gateway West, Newburn Riverside, Newcastle upon Tyne, NE15 8NX. True Potential Wealth Management is a Limited Liability Partnership. OC356611.
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