Five ways to deal with Market Volatility

If you’ve felt that 2022 has been a volatile year on global markets, you’d be right.

According to LPL Research, in the US, 87% of trading days (up until Sep 1), saw intraday swings of more than 1% on the S&P 500. This is a level not seen since 2008.

The VIX, which is also known as the ‘fear index’, is the standard measure for volatility. In the US, it spent most of the year at elevated levels, averaging around 26, whilst the long-term average is just 19.5. Noticeably, towards the end of the year the VIX began to ease, as inflation expectations also eased.

In Australia, volatility has been much more subdued in 2022, with the Australian S&P/ASX 200 VIX index staying largely within the normal range for most of the year.

What is Volatility?

Volatility is the measure of fluctuation in the price of a security or index from its mean, over a period of time.

If a stock moves in a narrow trading range, then it has a low standard deviation and low volatility. A wide trading range would suggest a high standard deviation and high volatility.

Volatility is normal, and there is always a certain amount of it in the market. However, every now and then, such as in 2022, markets can become a little more volatile than normal.

In a recent memo to investors, Howard Marks describes volatility as something that is not that important. There are, however, a couple of exceptions to this, such as if an investor has to make an imminent lump sum withdrawal, or has their portfolio tied to a margin loan.

Howard Marks also encourages investors to remember that volatility is always temporary and will pass.

He is also a strong believer that volatility is not a measure of risk, though some think it is. He believes that at best, volatility could be an indicator of the presence of risk.

What causes Volatility?

There are many factors that create volatility on the share market.

Firstly, there are world events such as the Ukraine war, China Taiwan tensions, pandemics, elections, or extreme weather events. Macroeconomic conditions such as inflation, interest rates, employment levels, and the prospects of recession can also cause volatility, as can government policy changes.

Changes in energy and commodity prices can also cause volatility. This can be to the resource companies impacted and also to the businesses that use these resources.

Every day there is also company specific news and profit announcements that may provide (good or bad) surprises to the market, causing volatility to those specific stocks.

Other factors that may cause volatility include the human emotions of fear and greed, and the differing investment strategies in the market. For example, there are long-term investors, short-term investors, and others that short stock. There are also those that buy and sell on margin, which can also increase volatility.

Dealing with Volatility

There are a number of easy ways an investor can deal with volatility. Here are five:

1. Preparation. When building an investment portfolio, be cognisant that volatility will come at some stage. As such, buy stocks or broad-based ETFs that can handle this volatility.
2. Diversification. Hold stocks or ETFs that ensure your portfolio is well diversified. When markets become volatile, often some sectors fall, while others rise. A well-diversified portfolio can help reduce risk.
3. Remember your financial goals. When volatility appears, the worst thing that you can do is follow the herd and sell everything. Remember your initial plan and stick to it. Think long term, and understand that volatility is normal and will eventually subside.
4. Take advantage of the lows. When markets are near their lows and volatile, it can often be a great time to invest. A popular strategy is dollar-cost averaging, which means you put a set amount into the market at regular intervals. When you buy in at low prices, you can make money when the market corrects itself.
5. Talk to your financial advisor. If markets become volatile, and you feel like you want to sell, don’t make any panicked moves based on emotion. Before making any major financial decisions, first talk with your financial advisor, and they’ll talk through your financial goals and advise whether the changes are right for you.

How does InvestSMART handle volatility? With decades of investing experience, our Investment Committee understand we cannot control or accurately predict macro-economic events. Therefore, we focus on what we can control and that is our diversification, costs and investment timeframe. We accept short-term discomfort for long-term gain. Talk with the team today via the chat in the bottom right. You can view our investment portfolios here.