Dealing with market volatility and uncertainty

It is with great exhilaration that today Optima Wealth is born. The purpose of the company is that “we enable choices”. How? We provide the discipline of prudent advice to protect wealth and better enable financial choices.

This is my first blog that I will share, which to me, is very exciting and hopefully it will be to you. The subject matter is quite topical given what is currently happening with financial markets. There have been quite a few alarming headlines in the media of late, in reaction to the recent market volatility. This year has been an interesting year for markets as volatility and uncertainty has returned after a very benign 2017 when markets just continued to rise every month. Fundamentally this year is no different than most other years that have gone by.

Firstly, we must consider the media and their role in reporting these events. The media always focuses on the short term moves in the market and not the long-term view as this makes better headlines. As an investor it is the long-term view that you should be focused on.

An academic study found that it is human nature for us to be more attracted to negative news than positive news even though we like to say, “We like good news stories”. So, in a way, the media outlets are just giving us what we want. As a long-term investor, you need look beyond the headlines, understand that the media is in the market of selling advertising and what drives advertising revenue is people viewing the content it produces.

Secondly, given all this volatility, should we be doing anything? Nobel Prize winner “Professor Fama’s” efficient market theory is based on markets move on new news. All existing news and market expectations are already baked into the priced.

Given this, unless your crystal ball is working better than mine or anyone else’s, we must admit that we cannot predict the future. Guessing the future regarding the economy, interest rates, political events, inflation figures, GDP growth, trade wars or any other unknowns is a near impossible task that relies more on luck than skill. Even if you got the predictions right, the market may then react in a completely different way than you expect it to. As we cannot predict tomorrow, it is then best to work with the market as it can be dangerous to make inferences about the future direction from what has happened from the immediate past.

As an investor, you can’t escape this market volatility, but you can moderate it by being well diversified across asset classes such as shares, bonds, property and cash and also within those asset classes.

For those still anxious here are seven simple truths* to help you live with volatility:

  1. Don’t make assumptions. Remember that markets are unpredictable and do not always react how the so-called experts predict they will.
  2. Some one is buying. Quitting the equity market when prices are falling is like running away from a sale. Prices fall to reflect higher risk, that’s another way of saying “expected returns” are higher. The media may say investors are dumping shares, but someone is buying them, and they are usually long-term investors.
  3. Market timing is unreliable. Recoveries can come and go just as quickly and just as violently as the prior correction. At the end of the GFC the US Market put in seven straight months of gains.
  4. Never forget the power of diversification. When equity markets turn rocky, other assets such as government bonds can flourish. This will limit damage to balanced investors by spreading the risk and smoothing the ride.
  5. Markets and economies are different things. The world economy is forever changing and new forces are replacing old ones. This applies both within and between economies. For instance, falling oil prices are bad for the Energy Sector but are good for the consumer.
  6. Nothing last forever. Just as smart investors temper their enthusiasm in good times, they keep a reserve of optimism in bad times. Eventually markets will always turn one way or another, we just don’t know when.
  7. Discipline is rewarded. Market volatility can be worrisome, no doubt. Through discipline, diversification, keeping focused on progress to achieving your long-term goals and accepting how markets work, the ride can be more bearable. At some point value will re-emerge, risk appetite awakens and for those who acknowledged their emotions without acting upon them, relief replaces anxiety.

What ultimately matters, is not the ability to second guess short term moves in the market. But how your portfolio is travelling relative to your own stated goals, risk tolerance and investment time horizon. Focus on them and the all the headlines then just becomes noise.

Working with a good adviser can help keep you focused on your long-term plan and rebalance your portfolio to ensure you are not taking more risk than you need to reach your objectives. So, switch off the business news, as if it is in the news today, it is already priced into the markets and we can't do anything about it. Tomorrow will be as it always is…. another day of unknown news.

* From Jim Parker's (Dimensional) book "Outside the flags 5"

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