7 steps to surviving investment volatility

Many investors may have had a roller-coaster ride recently. Fallout from the eurozone crisis has created the most turbulent period in world stock markets since the downturn began in 2008. However, amid all this gloom there is some good news. The simple truth is that volatility is a fact of investing life; you’re often better served staying in the markets over the long term than pulling out. Here’s why, and how, you can do it.

1. Remind yourself why you invested
Most people invest in order to achieve a better return than they’d receive from other forms of saving, such as bank deposits. While it may be tempting to squirrel away cash in a bank, pulling out of the market when it’s falling is one of the worst things you can do as you’ll simply crystallise your losses.

If you’d stuck with the FTSE All-Share Index over the past 20 years, your portfolio would have increased by 361 per cent, or 7.94 per cent a year. However, if you’d pulled out and missed the best 20 days’ performance, you’d have gained only 60.8 per cent, or 2.4 per cent a year [1]. Remember, though, that past performance isn’t a guide to future performance.

2. Remember your own time horizons and goals
Many investors overreact to short-term market volatility, which isn’t usually relevant to their long-term goals. Review your strategy and remind yourself why you’re investing – is it for your young children’s university fees or are you saving for retirement? These objectives are unlikely to have changed, even if the market has taken a tumble.

3. Don’t put all your eggs in one basket
The key to long-term investment success is having a good balance of investments – for example, diversify between different types of funds, equities, property and cash. Piling all your money into one asset class is high risk. Check where your funds are invested: spread holdings over different sectors and geographical areas. Review the balance of your assets: are you exposed to too much or too little risk? For instance, if you previously had 50 per cent of your investments in equity-based growth funds, it’s likely that market falls will have reduced this share as a percentage of the whole. You should check to see if this new asset allocation matches your risk profile.

4. Check your exposure to risk
The younger you are the greater exposure to equities you might want to accept, as you have more time to make up any losses. However, if the recent ups and downs have become too much for you, consider reassessing your attitude to risk.

5. Drip-feed your investments
Drip-feeding money into investments at regular intervals allows investors to smooth out risk through ‘pound-cost averaging’. This forces you to invest in all conditions, thereby helping to avoid the poor decisions that many people make when trying to second-guess the market. When the market falls, your payment will buy more shares or units in a fund so you’ll have a bigger holding when markets recover.

6. Take counter measures
Look at the type of investment funds you hold and make sure they are best placed to give you some protection when markets slump, but also to benefit when they bounce back. Good-quality fixed interest funds are likely to be relatively stable, whereas equity funds will be more volatile, so you should look to hold a combination in the right mix for you. You could perhaps consider absolute return funds, which aim to produce a positive return in all conditions. However, not all have produced the desired result amid the recent volatility and many charge performance fees on top of the annual management charge.

7. Change funds if they’re consistently underperforming
If certain funds are repeatedly failing to deliver, it’s time to assess whether they’re worth holding on to or not. Chopping and changing funds may incur management fees though, so you could consider using ‘funds of funds’, where the fund manager does this for you. ν

The price of units in investment-linked funds depends on the value of the underlying assets and can go down as well as up. You may not get back as much as you invest. Past performance is not a guide to future performance and should not be used to assess the risk associated with the investment.

As property is a specialist sector it can be volatile in adverse market conditions, there could be delays in realising the investment. The value and income received from property investments can go down as well as up.

[1] Figures correct to 07/11/11. Source: Standard Life Investments using Thomson Reuters Datastream.