Volatility is a common term in discussions about investing, but what does it really mean? Can it be avoided? And how should investors respond during turbulent market periods?
What is Market Volatility and What Causes It?
Volatility refers to the rapid and unpredictable fluctuations in the value of investments, moving both upwards and downwards. The values of equities and bonds are constantly changing as they interact within the larger financial system.
Numerous factors can influence market movements, including political speeches, economic policy announcements from leaders and central banks, major geopolitical events such as conflicts or energy crises, and daily updates from publicly traded companies, all of which shape traders’ opinions.
Given this dynamic environment, the value of your portfolio might decrease one day, drop further the next, and then rise again the following week. Predicting daily market movements accurately is virtually impossible. As a prudent investor, it’s advisable to focus on long-term outcomes and commit to investing for at least three years.
How Can Volatility Affect Me?
For many investors, seeing their portfolio lose value for the first time can be disheartening. Very few individuals experience a constant upward trajectory in their investments. It’s essential to recognize that volatility is a natural aspect of the journey toward achieving your long-term financial goals.
While it’s understandable to want to monitor your portfolio frequently, it’s likely that you will witness both losses and gains on different days.
Resisting the urge to adjust your portfolio based on daily fluctuations is crucial. If your chosen risk level and investment timeframe still feel appropriate, take comfort in knowing that you’ve made informed decisions aimed at reaching your long-term financial objectives.
Can I Avoid Volatility?
The reality is that if you’re investing in equity and bond markets, it is impossible to completely evade volatility.
For Nutmeg clients experiencing discomfort with market fluctuations, reducing exposure to riskier assets (primarily equities accessed through Exchange Traded Funds or ETFs) may be an option. This can be done by adjusting your risk level through the Nutmeg app or website.
Importantly, while past performance is no guarantee of future results, history illustrates that volatility can work in your favor if approached with a long-term investing mindset.
How Nutmeg Manages Risk
Understanding how Nutmeg addresses risk is vital. In our Fully Managed portfolios, the risk scale from 1 to 10 indicates the balance between higher-risk assets (equities) and more stable bonds, which typically exhibit less volatility.
However, remember that not all asset classes behave predictably. For instance, bonds faced significant challenges in 2022 as major central banks raised interest rates to curb inflation.
For those with a risk level of 1, investments are primarily allocated to developed market government bonds, the money market, or corporate bonds, with minimal equity exposure in developed markets (like the US, UK, Europe, or Japan).
Conversely, at the highest risk level of 10, the majority of the portfolio is invested in equities, including exposure to emerging markets like China and Brazil, with limited bond exposure.
It’s important to note that higher-risk portfolios are not comprised of unregulated or alternative assets, such as private equity or real estate. Nutmeg exclusively invests in liquid and transparent ETFs based on expert selection.
Should I Sell When Markets Are Volatile?
A critical point to remember is that a loss is only realized when an investment is sold. If your portfolio appears down today, it might have recovered by the time you decide to sell.
The timing of selling investments is contingent upon your personal circumstances. However, if you have established a suitable timescale and risk level, sticking to your strategy is generally recommended, provided you maintain reserves for emergencies.
The first year of investing can be particularly stressful, as shorter timeframes are more prone to illustrate losses compared to longer periods. It’s entirely natural for volatility to induce stress, especially if you’re not accustomed to seeing fluctuations in your financial figures.
Nonetheless, as illustrated in historical data, the likelihood of sustained losses diminishes over time, which can help mitigate anxiety. What seems like a significant shift on a particular day may be viewed as merely a temporary blip over several years.
A Fresh Perspective
Recognizing volatility as an inherent part of investing, along with the understanding that longer investment horizons decrease the likelihood of losing money, can alleviate some of your investment anxieties.
While no investment can guarantee returns, employing a measured approach over an appropriate timescale enhances your chances of achieving your financial aspirations.
If you’d like to discuss your financial goals further, consider booking a free consultation with one of our experts.
If you’ve found this article helpful, explore our additional pieces in the Investor Essentials series on compounding, diversification, and tax wrappers.
Risk Warning
As with all investments, your capital is at risk. The value of your Nutmeg portfolio may fluctuate, and you might receive less than you originally invested. Past performance does not reliably indicate future results.
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