My five tips on managing market volatility

Organising your investment toolkit.
My five tips on managing market volatility
Updated
September 1, 2021

Table of contents

The lie is that markets hate uncertainty. They thrive off it. It's individual investors that would rather things were a bit clearer sometimes.

But even if we managed to score a magical newspaper from a year in the future, we wouldn't necessarily be able to invest well off the back of it. For that, we'd need the money pages, definitely not the news.

Last year was a clear example of this. If someone had told you the US was going to experience the biggest quarterly drop in GDP since the financial crisis, would you have naturally assumed US shares would go on to reach record highs soon after?

The point here is we just aren't very good short-term fortune tellers. Where our efforts are best spent is in getting an asset mix that reflects our investment personality and then making sure we know how to cope with inevitable volatile periods.

As much as we would like a bit of certainty, volatility is the price we pay for the hopeful long-term outperformance of equities over cash. As investors, we need it.

Here are five ways I’ve learnt to cope with the ups and downs, and prep the war chest, before volatility rears its head.


1. Don’t feed the beast

One of the things we aren’t very good at is making decisions under pressure. 

The trouble is that we feel compelled to do exactly that when market volatility strikes. 

It brings fear, excitement, anxiety and a host of other emotions into the investing process at a time when they just aren’t welcome.

So, before 2021 gives our pulses cause to race, remember that volatility is a normal part of investing.

It’s to be expected from time to time and is the price we pay for the long-term historical outperformance of shares over cash.

And, as investors, we actually need it. Volatility is what allows shares to rise too, it’s not just a word to describe the down days. 

When things get choppy, try not to react rashly. Take a step back and remember this is what we all signed up for.

Helping yourself to understand that now means you are less likely to rush into emotional decisions later.


2. Diversify

It’s important that we realise the narrative behind our investments won’t always play out as we expect. It might take longer, it might be choppier or we might have just got it wrong.

That’s why holding a range of stocks with different prospects and external influences makes sense at the best of times. 

But 2020 showed why it’s useful to diversify between uncorrelated asset types too. 

Alternative assets like gold grew in popularity last year as the market demonstrated sometimes whole asset classes can suffer, not just individual companies.

So whether it’s a case of redefining your appetite for risk or having a look at how your portfolio is set up to deal with a shock to stocks, don’t forget about including assets which act differently to each other. To help you, we've explained in detail what portfolio diversification is all about.

Guide: Investing in commodities


3. Don’t get too buoyed by a gain, or too distraught at a loss

A good investor will try to stay measured no matter what is happening around the world, or in their portfolio.

If you start punching the air when the screen turns green you’re attaching too much emotion to your stocks. 

Excitement like that could also be a sign that it was a surprise or your short-term punt paid off. These are more common occurrences among gamblers, not investors.

Being held to ransom by your emotions also means you’re likely to get toppled off that pedestal pretty quickly if the opposite happens.

Thanks to behavioural economics icons Richard Thaler and Daniel Kahneman we know that we are likely to experience the pain of a loss twice as much as the joy of a gain.

Do your research, stay calm and keep the long-term journey front of mind.


4. Manage risk, plan for opportunity

When the police arrive at the house party, sometimes even the nice kids get nabbed. 

In the same vein, when volatility strikes a whole market or sector, sometimes even the good companies are taken down by the crowd. 

That’s when it pays to already have your shopping list at the ready, so you can snap up the stocks you like at bargain prices.

Of course, we don’t know what will cause the next pullback and it might be that your prospective companies start to lose their shine. 

If not, it can be a good chance to finally build a position for the long term.

A lot of price-conscious professional investors have their wishlist at the ready so they can assess the damage in a downturn quickly and decide if it’s time to invest or walk away. 

And that applies to the stocks you currently hold too - is it a chance to buy more of what you like, or sell?

Remember though, keep emotion to a minimum by doing as much of the work beforehand as possible.

Guide: Understand investment risk


5. Conduct a pre-mortem

Warren Buffett has always advocated that if you aren’t ready to see your portfolio drop by 50% you aren’t ready to invest.

So put yourself in that position now. Imagine your investments have suddenly halved and get a plan of action together. 

It might be that you know you’re likely to panic so write yourself a clear and concise reminder of what the calm version of you wants the panicker to do.

Interrogate your stocks now too. What might cause them to plummet? Are you happy taking the risk now, given that possibility? Could you realistically cope with that? 

The answers here will depend entirely on you, and the kind of stock, whether it’s a pharma company pinning all its hopes on a drug trial or a steady compounder slowly growing revenues.

Having the conversation with yourself now could be one less thing to think about later. 

It’s unlikely you’ll be able to predict the future in detail but simple guides for your future self on staying calm, reassessing your holdings and looking at any weak points in your portfolio now, or companies you’d like to add, can make volatile periods more manageable.

Learn more:

How to invest in the stock market

Savings vs investing - which is better?

How to choose the best investment app

Investing in penny stocks

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