Isn't it true that fluctuating investments can make us all jittery? Yes, right. Especially when your investments tend to slide! This is something we'll be discussing in this article. For quite some time, the stock market has been on a roller coaster ride & how! You might be thinking about whether to invest or wait for the market to quiet down at this level of volatility. The fact is that stock markets are by their very nature volatile.
Better volatility allows investors to earn a higher return because every dip provides an opportunity to invest. However, if an investor cannot absorb a notional loss, which is often short-term in nature, the risk of losing money is considerable. To maximize gains, the most important rule of investing is to get your money in at the proper time. When the market falls, you can increase your investment to maximize your return. But how can this be accomplished? Let's look at a few pointers to help us comprehend the same.
What is Market Volatility?
The regularity and severity of market swings, whether up or down, are referred to as market volatility. The market is said to be more volatile when price movements are larger and more frequent. In other terms, a volatile market is one in which the stock market rises and falls dramatically over time. Furthermore, if you invest in riskier investments, you can expect them to be more volatile. As a result, it is suggested that one should invest according to their risk appetite.
How is volatility calculated?
The standard deviation of a stock's annualized returns over a certain period is called volatility, and it indicates the range in which its price can move up and down. Herein, high volatility is defined as a stock's price fluctuating fast over a short period, hitting new highs and lows. And Low volatility is defined as a stock's price moving up or down slowly or being reasonably stable. Also, Historic volatility is determined using a series of past market prices, whereas implied volatility is derived using the market price of a market-traded derivative such as an option to look at predicted future volatility.
What are the causes of Market Volatility?
Among the factors that can cause volatility are:
1. Performance of the company - Volatility isn't always market-wide; it might also be specific to a particular company. Positive news, such as a solid earnings report or a new product that is impressing customers, can boost investor confidence in the company. Also, If a large number of investors want to acquire stock, the stock price may rise as a result of the increased demand. Not just that, a product recall, data breach, or bad management behavior, on the other hand, can all cause investors to sell their stock. This favorable or poor performance might have an impact on the larger market, depending on the size of the company.
2. Industry & Sector Factors - Within a particular business and sector, specific events might produce volatility. For example, in the oil industry, a significant weather event in a large oil-producing region might cause oil prices to rise. As a result, oil distribution-related companies' stock prices may climb, as they are likely to benefit, while those with significant oil costs in their business may see their stock prices decline. Similarly, higher government regulation in a particular industry could cause stock prices to fall as a result of increased compliance and labor costs, which could affect future earnings growth.
3. Political & Economic Factors - Economic data is important because when the economy is doing well, investors are more likely to respond positively. Market performance can be influenced by monthly job reports, inflation data, consumer spending figures, and quarterly GDP calculations. If these, on the other hand, fall short of market expectations, markets may become more volatile. For Example - you might have seen that due to the rising inflation, the RBI increased the repo rate & we could see market volatility that week!
Coming to the political factors, When it comes to trade agreements, laws, and policy, governments have a big role in regulating sectors and can have a big impact on the economy. Everything from speeches to elections can prompt investors to respond, affecting stock prices. And this, in turn, causes the markets to be volatile.
Should you sell your investments when the markets are volatile?
When stocks are under discount, sticking to a long-term plan can help you amass more shares. Market volatility decreases over time, and prices rise. The answer is usually no. If, however, you are in a position where you need the value of your assets fairly immediately or for income to live on (for instance, for a retiree), it may be best to rotate out of stocks and into more conservative investments when volatility strikes.
How can a smart investor be prepared for market volatility?
1. Keep your emergency fund intact - Your emergency fund amount will be determined by your lifestyle, monthly expenses, and income. It is recommended to accumulate at least 3 to 12 months' worth of spending in a liquid account like a bank savings or money market account. When the stock market is down, having an emergency fund can prevent you from having to sell your investments. When we keep enough cash on hand to cover unforeseen expenses, it gives us peace of mind when the markets are volatile.
2. Diversification - Higher market volatility entails greater risk. We could estimate our risk tolerance based on our age, financial goals, and net worth as competent financial advisors. However, for someone who has had a terrible investment experience in the past, this could still be bad advice. We all have various life experiences that impact how we perceive risk. The solution is to have a diverse investment strategy in place to ensure that your finances are managed in a way that fits your objectives and helps you to sleep well at night. As It's less likely to lose all of your eggs at once if they're not all in the same basket!
3. Set Realistic Expectations - Setting the expectation that our account value may be down 20% of the time can help us remain calm during market volatility. Short-term market changes can elicit a wide range of feelings. It is critical to take a step back and consider the big picture whenever feasible. Viable investment techniques can help investors endure volatility, which usually lasts a few days, weeks, or months. Knowing what to expect from the stock market and its volatility can help you and your investments succeed.
4. Know your investments - Not all investments come with the same level of risk! For example, if you only have 6 months to invest your money, it is best to invest in low- to no-risk assets to avoid losing your money. As a result, knowing where to invest according to your time period, financial goal, and risk level is vital!
5. Do not panic - Selling your stock during a bad market has no benefit, and it may even cost you money in the long term. Hold on to your stocks if you already have a sizable holding. Holding the majority of your present stock investments increases your chances of profiting from a market upturn. And hence, it is suggested to stay calm during the times of market volatility!
Lastly to summarize, as an investor, you should be mindful of risk during periods of high volatility, but do not panic and, above all, avoid making decisions based on fear. And Remember that a volatile market can be caused by a variety of economic factors and may not be sustainable in the long run.
And it is truly said that,
Market Volatility is not the cause of worry..
The actual worry is the volatility in the minds of investors !!
- TEAM IFA