In the world of investing, understanding market volatility is akin to navigating a rollercoaster ride. Recently, the Australian share market entered what experts call a “technical correction”. To put it simply, this term signifies a market fall of 10 percent or more from a recent peak. For instance, the S&P/ASX200 reached its all-time high at 7,628 in August 2021 and peaked at 7,558 on February 3rd of this year. Last Monday, the benchmark share index closed at 6,844, down 10.3 percent from its all-time high and 9.5 percent from its peak in February. It’s clear that the market is experiencing a bout of uncertainty.
Market volatility is a factor every investor encounters sooner or later. In this blog post, we’ll delve into what market volatility is and how to reduce risk for your investments.
What is market volatility
Market volatility refers to the natural fluctuations in the value of financial assets over time. It’s a reflection of the dynamic nature of financial markets and can be influenced by various factors, including economic conditions, geopolitical events, and investor behaviour. Recognising that volatility is an integral part of the investment landscape is the first step in making informed decisions.
Factors contributing to market volatility
When international conflicts, like the imminent Israeli ground invasion of Gaza, arise, they can increase geopolitical risks in the Middle East. If a more extensive war involving major players like Iran and Saudi Arabia unfolds, it could disrupt the global economy and cause a sustained shock in oil prices. These geopolitical events can have a significant impact on financial markets.
It’s essential to consider the broader economic context. For example, during the Gulf War, the U.S. experienced a recession. Similarly, the U.S.-Iraq war in 2003 occurred after the tech crash. Currently, the conflict in Israel is happening as U.S. bond yields reach their highest levels since 2007. These economic factors interact with geopolitical risks, further affecting market returns.
The COVID-19 pandemic led to economic stimulus and border reopenings in late 2021. This resulted in some of the highest inflation rates in decades. Inflation can be problematic because it erodes the value of your money and investments. Now, with a looming war, the price of petrol and international politics are at stake. All of these factors point to one thing: the possibility of higher interest rates for a more extended period.
Investors often become cautious during volatile times and may temporarily stay on the sidelines, avoiding active trading. This behaviour can reduce market activity and add to the overall unpredictability. For example, if bonds offer a better return with lower risk compared to equities (stocks), some investors may shift their investments from stocks to bonds. This can affect the overall performance of the stock market.
How to reduce risk from volatility
Embracing a long-term perspective
A key strategy in dealing with market volatility is adopting a long-term perspective. Younger investors have the advantage of time on their side. A long-term perspective allows you to leverage the benefits of compound interest and ride out short-term market fluctuations. In the bigger picture, these temporary swings are of lesser significance compared to your overarching financial objectives.
Diversify your investments
Another key strategy to mitigate the impact of market volatility on your investment portfolio is diversification. Spreading your investments across different asset classes, such as stocks, bonds, and real estate, can help maintain stability during turbulent times.
Avoid impulsive decisions
Market volatility often triggers emotional responses. Investors may experience stress and anxiety, leading to impulsive decisions. Crafting a well-thought-out financial plan and staying informed can help you keep emotions in check, ensuring rational investment decisions.
Get professional guidance
Getting professional advice is often sensible to mitigate risk from market volatility. A financial advisor can offer expert guidance tailored to your unique circumstances and goals. They can help you develop a long-term, well-diversified financial strategy that helps you navigate market volatility. They can also help to keep you on course to reaching your goals and take the emotion our of your investment decisions.
Navigating the uncertainty
In summary, market volatility is influenced by a complex interplay of geopolitical conflicts, economic factors, inflation, and investor behaviour. It can be unsettling for investors, especially those nearing retirement. However, it’s important to keep in mind that market volatility is a part of investing. Having a well-diversified, long term financial strategy, and seeking professional advice can help you navigate the rollercoaster ride of financial markets.