7 steps to surviving investment volatility
17 February 2012
by Alexandra Goss for Standard Life
Many investors will have had a roller-coaster ride recently. Fallout from the eurozone crisis has created the most turbulent period in world stock markets since the downturn began in 2008, hitting pension funds, ISAs and other investments.
However, amid all this gloom there is some good news. The dividends paid out by UK companies continue to rise, providing much-needed income for those seeking to beat the effects of inflation. The simple truth is that volatility is a fact of investing life; you’re often better served staying in the markets over the long term than pulling out. Here’s why, and how, you can do it.
Most people invest in order to achieve a better return than they'd get from other forms of saving, such as bank deposits. While it may be tempting to squirrel away your cash in a bank, pulling out of the market when it's falling is one of the worst things you can do as you'll simply crystallise your losses. If you'd stuck with the FTSE® All-Share Index over the past 20 years, your portfolio would have soared by 361%, or 7.94% a year. However, if you'd pulled out and missed the best 20 days' performance, you'd have gained only 60.8%, or 2.4% a year(1). Remember, though, that past performance isn't a guide to future performance.
Many investors overreact to short-term market volatility, which isn't usually relevant to their long-term goals. Review your strategy and remind yourself why you're investing - whether it's for your young children's university fees or you're saving for retirement. These objectives are unlikely to have changed even if the market has taken a tumble.
The key to long-term investment success is having a balance to your investments. Piling all your money into one asset class is high risk - for example, diversify between different types of funds, property and cash. Check where your funds are invested: spread holdings over different sectors and geographical areas. Review the balance of your assets: are you exposed to too much or too little risk? For instance, if you previously had 50% of your investments in equity-based growth funds, it's likely market falls will have reduced this share as a percentage of the whole. You should check to see if this new asset allocation matches your risk profile (read pt 4).
The younger you are the greater exposure to equities you might want to accept as you have more time to make up any losses. However, if the recent ups and downs have become too much for you, consider reassessing your attitude to risk. Our simple 10-question test will help you understand your current investment risk profile. To find out more use our risk questionnaire.
Drip-feeding money into investments at regular intervals allows investors to smooth out risk through ;pound-cost averaging'. This forces you to invest in all conditions, thereby helping to avoid the poor decisions that many people make when trying to second-guess the market. When the market falls, your payment will buy more shares or units in a fund so you'll have a bigger holding when markets recover.
Look at the type of investment funds you hold and make sure they are best placed to give you some protection when markets slump, but also to benefit when they bounce back. Good quality fixed-interest funds are likely to be relatively stable, whereas equity funds will be more volatile, so you should look to hold a combination in the right mix for you. You could perhaps consider absolute return funds, which aim to produce a positive return in all conditions. However, not all have produced the desired result amid the recent volatility, and many charge performance fees on top of the annual management charge, so check before investing.
If certain funds are repeatedly failing to deliver, it's time to assess whether they're worth holding on to or not. Chopping and changing funds may incur management fees though, so you could consider using ;funds of funds', where the fund manager does this for you.
MyFolio does the hard work so you don't have to
You can find some of these volatility survival techniques in our MyFolio Managed Funds, which are five readymade portfolios of funds with different levels of risk. You pick the fund that most closely matches your appetite to risk, we’ll do the rest. We’ll ensure the fund maintains an appropriate asset mix and risk level, and we’ll monitor performance on an ongoing basis to make sure it’s on track to meet its objectives. You get all of this for a single fund management charge. Find out more about Standard Life MyFolio funds, including their risks.
Please remember: the price of units in investment-linked funds depends on the value of the underlying assets and can go down as well as up. You may not get back as much as you invest.
(1) Figures correct to 07/11/11. Source: Standard Life Investments using Thomson Reuters Datastream.
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