Market Volatility: Friend or Foe?
Are you the type of investor who gets worried or panics whenever the stock markets decline by three percent or more in a single day? If you are, it is time to stop looking at your investment portfolio on a daily basis. After all, investment fortunes are made over the long run and not overnight.
Wouldn’t investing be so much easier if the stock market moved according to a strict set of agreed rules or rhythm over time? For example, imagine if prices rose in the first week of every month, remained steady for another week, before gradually falling back to the previous levels as shown in the diagram below.
With this knowledge in mind, you can probably buy during periods when prices are low and sell at higher levels. Repeating this process every month should provide you with ever-increasing wealth as long as your buying and selling does not affect the hypothetical market fluctuations.
Unfortunately, markets do not follow these patterns in reality. Attempting to ‘time’ buying and selling decisions in the short term is a risky activity, and something that very few professional investors manage to do successfully on a regular basis. This is because market movements can be volatile (Figure 1). Unexpected news, either specific to one company or the economy as a whole, can significantly influence stock prices in the short term. Meanwhile, psychological factors such as a change in risk appetite due to fear or greed can also affect market activities.
Looking Past Short-Term Volatility for Long-Term Gains
Over the long term, equity funds tend to outperform both bond and money market funds. However, in the short term, equity funds may demonstrate a higher volatility of returns compared to fixed income funds. During these periods of elevated volatility, it is common for investors to be anxious and worry about the value of their investments.
Due to the volatility in the equity markets, many experts advise investors to take a long-term view of their equity investments. This is because a longer time frame is needed for companies to grow their businesses. Well-managed companies generally continue to grow with time and are able to ride through short-term periods of cyclical weakness.
The Folly of Market Timing
During periods of market volatility, investors might be tempted to delay making investment decisions or may even sell their existing holdings in the hopes of buying back when prices are lower. While market timing seems to be an attractive method of investing, it is difficult to achieve in practice. Just as sharp declines in stock markets tend to occur over short periods of time, the strong gains may be similarly concentrated. Because these gains could occur following a sharp market retracement, an investor who tries to avoid these declines is likely to miss the gains of any subsequent recoveries.
Market Volatility Presents Investment Opportunities
Following the steep decline in equity markets at the onset of the Covid-19 pandemic in 1Q 2020, some investors have hesitated to invest and/or have sold off their equity holdings in panic. However, the equity markets quickly recovered.
After declining by 34% from the end of January 2020 to a near 3½ -year low of 18,592 points in mid-March 2020, the U.S. Dow Jones Industrial Average rebounded by nearly 40% by the end of June 2020 as extensive fiscal and monetary stimulus was introduced to support the economy. Subsequently, the U.S. equity market continued to rise to new record highs by the end of 2020 and throughout 2021 as the U.S. economy began to recover from the pandemic.
Therefore, during periods of volatile market conditions, investors are advised to remain calm, think rationally and keep their emotions in check. As long as you have a long-term investment horizon, short-term market volatility can be used as a potential opportunity to invest at attractive prices.
When the markets consolidate, many people become fearful and will be reluctant to invest. While this may help avoid some losses in the short term, individuals who have avoided investing because of the earlier volatility will lose out on the potential gains when markets eventually recover. In comparison, those who invest a fixed amount on a regular basis would have bought at bargain prices with a lower average cost.
Thus, investors should consider practising Ringgit-Cost Averaging (RCA) for their investments. This technique works by investing a fixed amount of money at regular intervals, regardless of how the market is performing. By adhering to a disciplined approach of investing no matter how the market is doing, investors will be in a better position to benefit when the market bounces back, and will avoid the urge to time the market.
This article is prepared solely for educational and awareness purposes and should not be construed as an offer or a solicitation of an offer to purchase or subscribe to products offered by Public Mutual. No representation or warranty is made by Public Mutual, nor is there acceptance of any responsibility or liability as to the accuracy, completeness or correctness of the information contained herein.