Every investor should know that their capital is at risk – after all, there is no such thing as a free lunch. Another cliché which lends itself to investing is that whatever goes up must come down, and this is certainly true when it comes to stock markets.
It's never nice to see your investments fall in value, but it is a normal occurrence in the market cycle. It is very rare for markets to move in a straight line – bull markets will have corrections and bear markets will have rallies.
But rather than trying to second guess the direction of investments, there are different strategies you can use to mitigate, or even take advantage of, market volatility.
At the risk of sounding like a broken record, diversification is key. If everything in your portfolio is rallying at once, this could be a warning sign that your capital is at greater risk to a change in market direction. With smart asset allocation, you can put your portfolio in a good position to potentially fall less than the wider market. You can dovetail your equity exposure with other asset classes such as bonds, property, gold, absolute return funds (which aim to provide positive returns in all market conditions) and even cash.
Some funds are better equipped to deal with falling markets than others. This is because they are able to 'short' stocks, which essentially means they can make money when the share price falls. This is done by entering into a contract to sell an asset that the fund manager views as overvalued and buying it back for less on a specific date. If the manager is right, they will make a profit. However, the value of an asset can go up or down. So if you short a stock and the price then rises, the losses can be painful. This is why shorting has typically been the preserve of skilled professional investors and hedge fund managers. Expertise and experience are crucial.
At the opposite end of the spectrum, those who have a stronger stomach for risk may wish to take the opportunity to snap up bargains during market corrections. Volatility isn’t necessarily a bad thing and there are sometimes opportunities in turbulent times. Protecting your portfolio should absolutely be your first priority but, if you buy something that’s cheap, you’ve got a better chance of making money in the long run.
Most of us invest in lump sums, whether it’s a few thousand hurriedly put into an ISA before the end of the tax year or an annual bonus or similar payment. Another approach, however, is to invest smaller amounts regularly – say once a month when you get paid. One of the benefits of this approach is that it helps you stay focused on your long-term goals, as instead of seeing the value of your portfolio change dramatically (which is what happens when you put in a lump sum), it ideally grows steadily over time.
Regardless of which investment style you prefer, it is fundamental to look through any short-term market noise. Time in the market is always a better option than timing the market (seeing as, sadly, nobody has a crystal ball).