As any long-term investor can tell you, fluctuations in financial markets are inevitable.
All investment carries the risk that markets will periodically suffer from price declines. Some of these may be gradual, while others may be sharp and sudden - a most recent example is what has been experienced at the outset of the Covid-19 pandemic. These periods of price volatility can leave many investors understandably concerned - but it's important to maintain perspective and focus in order to navigate through these times.
First, it is important to remember that volatility is to be expected from time to time. Market corrections are a natural part of the investment journey, and can be driven by geopolitical or social events, the influence of economic data releases, investor sentiment or any number of other factors which are often beyond our control as individuals.
While this can be distressing, it is during these periods when it is most important to remain calm. Rather than fixating on the market downturn, investors should keep their focus on why they invested in the first place. Whether it's for the potential of better returns, a retirement plan or to manage wealth, it's essential to keep sight of your original long-term investment plan.
Volatility may be painful, but it can also create significant investment opportunities. When investor sentiment is negative, the price of investments can be driven down well below their true value. This provides an opportunity to buy into the market at lower prices, with the potential for better returns in the long run.
The question many investors will find themselves asking at this time will be this: to what extent should I stay invested amidst market volatility? History does not necessarily repeat itself, and markets may not always follow the same recovery paths.
However, there are lessons to be learned from prior experiences. History shows that financial markets tend to go up in the long run, despite short-term fluctuations. When investors overreact to market conditions, they may miss out on some golden opportunities. Whilst nobody can predict exact market movements, periods in which the prevailing mood is overwhelmingly negative can often turn out to be among the better times to invest.
The strongest market performance is often seen directly after the largest downturns. 2020 was an exemplar case study for such behaviour. It is natural that when markets are destabilised, investors will be tempted to make a quick exit in order to avoid losses. However, for those investors who are able to rise above the chaos and take a longer-term view, this may actually be an ideal buying opportunity. Investors giving in to unsettling circumstances and selling may end up forfeiting the opportunity to benefit from any sudden market resurgence, potentially crystallising a loss.
Ultimately, staying invested for longer periods generally tends to offer a higher return potential, simply because long-term investing increases the chance of positive returns.
If you are concerned about market downturns, the key is to diversify. Different asset classes tend to perform differently under various market conditions due to their unique characteristics or relationships. By combining assets with different characteristics, the risks and performance of different investments are combined, thus lowering overall portfolio risk. That means, a loss in one asset class may be compensated by a gain in another.
It is also important that your investment portfolio remains aligned to your current lifecycle stage, attitude to risk and goals. This is why regularly reviewing your investment portfolio with your trusted financial planning adviser is of paramount importance.
Adopting a regular investment strategy can also be useful. Investing regularly means continuous investment regardless of what is happening in the markets. When investors make fixed regular investments, the price at which units are bought averages out, which in turn will smooth out the investment journey. The outcome of such a strategy can help to address some of the worry that comes with sudden drops in the market, or of buying when prices may seem too expensive.
On a final note, investors must not let short term market fluctuations take over their feelings and dictate their long term ambitions. Ask yourself whether there have been any significant changes to your personal circumstances, investment objective, and risk profile to warrant a review of your original investment plan. If so, reach out to your trusted financial adviser to guide you.
This article was written by Konrad Borg Myatt, CEO of HSBC Global Asset Management (Malta) Ltd. It first appeared in the Times of Malta on 9 April 2021.