Volatility is a given in the investment world, and in the past year investors have been exposed to several events that sparked short-term volatility.
There were irregularities in corporate finances, sovereign events like the ANC elective conference and concerns about rising inflation in the United States, which led to a sharp decline in US markets earlier this year. When the headlines look bleak, many investors become excessively pessimistic and reactionary. This can be more detrimental to long-term wealth creation than the volatility that sparked it in the first place.
Here are the four best investment lessons:
Volatility brings risks – but also rewards
In equity markets, volatility is inevitable. Consider it the “nature of the beast”. Unfortunately, many people panic at the first sign of market corrections. This is usually when wealth managers receive frantic calls from their clients, because the value of their investments has suddenly decreased. What many investors lose sight of in uncertain times and sharp corrections is the fact that this volatility provides investors with opportunities to access markets at lower prices.
Despite this short-term volatility, equities have the highest potential to create wealth
Equities have proved time and time again that as an asset class they deliver the highest returns over the long term. It is a risky asset class, however, with the potential for large losses in capital over the short term, so the duration of your investment is crucial. The inherent risks are reduced and eventually negated if your investment horizon is longer than five years. If you can’t commit to five years – and preferably longer – equities probably aren’t the right investment for you.
The biggest threat to your wealth-creation efforts is you
The inherent fear of losing money drives many investors to make poor decisions. Research shows that we feel the pain of losses far more acutely than we enjoy gains. This is referred to as loss aversion, and it’s the reason investors are more likely to make irrational decisions based on losses than they are to be reckless with gains. Emotions related to losses weigh so heavily on some investors that they would rather sell-off their equity investments, in this way locking in the losses permanently, rather than stay invested and risk further losses in uncertain times.
Use volatility as an opportunity to ensure your portfolio is still correctly positioned
A hands-off approach to your investments can be healthy in volatile times, but don’t be so passive that you miss out on necessary tweaks and updates. Corrections often prompt market participants to perform sanity checks, which is very healthy. Sometimes periods of volatility will bring to light shortcomings in your overall investment strategy or portfolio construction. This can be a necessary prompt to reconsider whether your current position is still best suited to your needs. A plan put in place 10 years ago may well need to be adjusted and rebalanced. It’s also a good time to check that your portfolio is appropriately diversified, one of the best ways to mitigate the risks inherent in equity investments.
. This article was originally written by by Adriaan Pask, chief investment officers at PSG Wealth, and adapted for publication by Heinn Havinga, a financial planner at PSG Somerset Mall, in partnership with Servaas Haasbroek and Jac de Wet. For more info, contact the PSG Somerset Mall team on 021 851 3353.
