Why market volatility is not always bad
The uncertainty of the last year, as the world has adapted to the many impacts of the coronavirus, the oil price war of 2020 and the impacts of Brexit, have brought into attention, and reminded many people, that financial markets can be volatile.
In 2020 and 2021, stock markets, bond markets, exchange rates and other financial measures have experienced sometimes daily ups and downs and across a broader range than what has been experienced in previous years.
Volatility simply means a change in an asset’s prices from one period to the next.
There are some key reminders sparked by these market movements that we would like to share with you:
1. Volatility is normal
The first reminder is that volatility in a market can make investors feel uncomfortable, but in reality volatility is normal. Markets tend to have short memories and when markets are going up, it can be forgotten that they can go down as well. Volatility, or a change in market prices from day to day or week to week, are a reflection of the efficient market working as underlying investments move away from, and return to, fair value.
2. Volatility shrinks over time
An important characteristic for the long-term investor is that volatility reduces over time. The volatility in one day is typically less than volatility in a week, which is less than a month which is less than a year. Another way of looking at this is that the risk of making a loss in an investment in one day is much higher than making a loss in an investment that is held for ten years. This risk from volatility won’t completely disappear over time, but it will reduce.
What does that mean for investors?
It means it is important to stay focused on your objectives – the reasons for investing and ignore the short term movements if your investments remain aligned to your long term goals.
3. Volatility can generate returns
Volatility cannot be removed from an investment completely. Moreover, it can be helpful in generating returns. Changes in asset values, in both directions, can add value to your investment. Getting that balance right between taking advantage of market movements and being reactive can be difficult and is best left to the professionals. Used in the right way, in alignment with your overall strategy, it can help you in reaching your goals.
4. Markets have cycles
It is inevitable that markets have cycles. Historically market cycles have occurred at an average of every 7.5 years from peak to peak or trough to trough. Therefore, in a long-term investment, you should expect to incur some periods of down markets. These can present opportunities to grow your investments in the knowledge that over time the market trend is up, it is just not in a straight line.
You should expect markets to go down and have negative periods, or times of more volatility than normal, and these events should be factored into your long term financial and investment plans. If they are, you won’t have as much to worry about then the market does drop.
In summary, the 2020 and 2021 financial markets have reminded us to expect market movements. It reminds us to differentiate between short term movements and long term trends and to remain focused on your long term investment objectives – why you are investing.
If you are in doubt that you are investing in line with your objectives, would like a review of your existing investments, or simply have questions about how to navigate the complexities of investing as an international professional living in Europe, contact us at Black Swan Capital at info@blackswancapital.eu.
