Investing in a volatile market

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"I buy on the assumption that they could close the market the next day and not reopen it for five years." – Warren Buffet

Warren Buffet, arguably the world’s most successful investor, has long championed the 'buy-and-hold' investment strategy on quality stocks. It's a philosophy many aspire to, but history has shown that rarely do we have the patience.

Patience – and more specifically the lack of it – like greed, fear and even joy, are the very human emotions that can impact an investor’s ability to make rational investment decisions.

These emotions are particularly apparent in times of high market volatility – but what is volatility and how does it affect the market?

Market volatility and its effect on the market

If you see your share portfolio rise for three days, plunge for two and rally for another five – maybe for no net gain or loss – what you are witnessing is the market’s volatility.

Mathematically, volatility is derived from the fluctuation, (or standard deviations), of a security’s price around its average price over a period of time. Simply put, volatility is a reflection of investor sentiment based on the risk they see in the market.

Studies have shown that periods of high volatility are often associated with falling markets. This is somewhat intuitive as investors often react emotionally, selling their investments when prices fluctuate wildly and downside risk increases. Conversely, periods of low volatility often reflect an increasing market and as fund managers and investors become more content, so too are the risks of a market correction.

What affects market volatility?

Whilst there is often no one cause for volatility over any time frame, there are some conditions which can lead to market volatility, including the likelihood of government influence and  intervention, the perception of a market bubble (eg dot com, housing), instability in global affairs and more generally any situation where investors cannot get a reliable picture of the future.

Top tips for living with market volatility

1) No-one can time the market

‘Timing the market’ – that is, consistently selling high and buying low is very difficult. Unfortunately, markets are unpredictable and attempting this can leave investors prone to missing out on relief rallies – not to mention the tax implications on profit-taking.

For that reason, we believe in the old mantra – ‘time in the market is more important than timing’. Investors who stay out of the market, trying to pick the best time to invest, risk missing out on market rebounds. As you can see from the following graph to 31 December 2015, missing out on just 20 of the best trading days in Australia over the last 10 years virtually erased any gain you made. Importantly, it also lets you take the emotion out of investing and frees you up from watching the market every day.