Harvey Jones
21.01.2020
Don't panic about stock market volatility. It could be your best friend
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What's the single biggest thing that stops people from investing their money in stocks and shares?
Anecdotally, my answer would be volatility.
When friends and family talk to me about investing, I advise them to put most of their long-term wealth in the stock market, because over the years equities should outperform almost every other asset, and with a lot less effort than, say, managing a rental property. Some listen to me, some don’t. I'm not a financial adviser, I’m a personal finance journalist, so they can take my advice or leave it.
I’m not selling them anything.
Both those who do invest, and those who don’t, express the same fear.
They don't like the idea of never knowing what their money is worth. They get edgy at the thought that its value can swing from one day to the next, and those movements are entirely unpredictable.
They want steady returns and a clear idea of how much their money will be worth tomorrow and in, say, five or 10 years.
Some avoid the stock market altogether as a result, and make what I think is a terrible mistake.
Because over the longer run, stock market volatility isn't your enemy, and it isn't a threat to your wealth. Instead, it's one of the best friends you have.
Ultimately, it will make you richer, rather than poorer. But only if you treat it like any other friend, with respect.
High risk, high reward
Volatility gauges the range of potential returns when buying a particular stock, index tracker or mutual fund.
It measures both upwards and downwards movements, so a highly volatile investment could fly to the stars, but it could also crash down to earth, possibly in the same week.
As a general rule, the more volatile the investment, the higher your potential rewards, and potential losses.
So a racy technology start-up is at the extreme end of the volatility scale. It could be the next Amazon or Apple, or crash without trace.
At the other end of the risk scale, cash demonstrates low to zero volatility. You know what you will get, and it won’t be much.
You have to accept a degree of volatility, if you want your invested wealth to grow ahead of inflation over time.
The good news is that with careful planning, you can largely avoid the downside, while taking full advantage of the potential upside.
Think long-term
Volatility is largely a short-term issue. The stock market goes up and down from day to day, and year to year, but you shouldn’t measure the success of your investments over such brief time periods.
Never invest money in stocks and shares that you will need in the next three to five years, and ideally, far longer than that.
If saving for retirement, you should be investing for 30 or 40 years, and can largely ignore short-term volatility.
It might be of passing interest to learn that, say, the S&P 500 or FTSE 100 is up or down 1% that day, but it shouldn’t affect how you invest your money.
If investing over decades, daily swings do not matter.
What does matter is that history shows that the general long-term stock market trend is upwards.
If you hold on for the long term, you can afford to ignore short-term volatility.
Smooth out short-term swings
By investing a regular sum every month, you can turn that volatility to your advantage.
This way you actually benefit when markets fall, because your regular monthly contribution picks up more stock or fund units, at the lower price.
This process is called dollar-cost averaging, or pound-cost averaging, depending on which currency you are investing in.
If you invest every month, the price at which you buy will vary, but should average out over time. This reduces volatility compared to, say, throwing in a single lump sum, with the risk that markets could crash next day, slashing its value overnight.
By investing regularly sums, you should actually cheer when share prices fall, as your monthly contribution will pick up more stock and units, which will be worth more when markets recover, as they always do in the longer run.
Fortune favours the brave
There is a price to pay for dollar-cost averaging, because stock markets tend to go up more than they go down.
This has been particularly extreme during the recent bull run, with the S&P 500 up in nine out of the last 10 calendar years (2018 was the exception). In the last 20 years, it has ended higher 15 times, and down just five.
Since 1926, the annual average long-term return of the S&P 500 is around 10% a year, according to Macrotrends.net.
So by investing a lump sum over a year, rather than all at once, you are reducing the risk of of a sudden crash, but also sacrificing potential growth.
It would have been much better to put money into the S&P 500 right at the start of 2019, before it had risen 28.9%. Less so in 2018, when it fell 4.38%.
The more volatility you can withstand, the more money you can potentially make.
Learn to love volatility
If volatility scares you, there are other things you can do to reduce it.
Spread your money around, by investing in a range of stocks or funds across different markets, sectors and countries.
Put some of your portfolio into cash, bonds, gold, property and other asset classes, that move in different ways to stock markets.
Invest for the long term, as I said.
The only way to eradicate volatility altogether is to stick your money in cash, and you don't want to do that.
Volatility shouldn't stop you from investing in stocks and shares but quite the reverse. It should encourage you.
Treat it as your friend, not your enemy.
Harvey Jones has been a UK financial journalist for more than 30 years, writing regularly for a host of UK titles including The Times, Sunday Times, The Independent and Financial Times. He is currently the personal finance editor of the Daily Express and Sunday Express, and writes regularly for The Observer and Guardian Unlimited, Motley Fool and Reader’s Digest.
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