In uncertain times, diversification is crucial. Market volatility highlights the need to ensure your portfolio is diversified.
The Dow Jones fell more than 1,000 points on Monday, 24 January 2022. The S&P 500, a larger gauge of the stock exchange, was in correction territory. This is a 10 per cent drop from its previous peak. Although all major indexes finished positively, they are still down since the start of the year. Recent market stress further highlighted the importance of diversification in portfolios. It is important to remember that investors rarely achieve their goals by only investing in one asset class.
Diversification means ensuring your portfolio has varied investments: investing in bonds and stocks, different industries, and small and large companies. The well-known phrase “Don’t put all your eggs into one basket” still applies today. This means you shouldn’t have all your money in one pot because you could then lose it all.
A wide range of assets
The initial response of financial markets to the coronavirus epidemic was muted. As the virus continues to spread, the response of financial markets has been more robust in the face of the effects on global demand, supply chain and tourism.
This makes it more attractive to diversify your portfolio by investing across multiple asset classes. This means that if one asset type performs poorly, it can offset another, giving you more balance in the event of market shifts. The investment returns of different asset classes and investment ‘baskets” vary greatly from year to year.
Our portfolios enjoy a smoother return profile as they are more diverse at both the asset-class and geographical level.
Many investment options are available in the stock, bond, and property markets. However, allocating your assets based solely on performance is not a good idea, as the market is constantly changing. A security type can perform well one year and then suffer severe underperformance the next.
Different stages of life are different for investors. Older investors might have a shorter investment time frame than younger investors. While risk tolerance is an individual choice, it is important to be realistic about your time horizon and to manage risk accordingly when you need access to different assets. It is best to sell assets when cash is required in the short term.
Diversification can also reduce risk in normal market conditions. If your portfolio includes many investments, it’s less likely that any one investment will fail. You will make more money from investments performing well than you lose on investments that don’t perform well.
It is impossible to prevent losses, but diversifying your portfolio and having a mix of assets can help you manage volatility in the markets. This is crucial to your long-term financial goals.
You can diversify your portfolio by investing in different asset classes. Government bonds and corporate bonds, for example, can offer different returns. However, the risk of defaults or non-payments is higher with the latter.
You can also diversify within one asset type. However, holding equity in multiple companies operating in different sectors will not protect you against systemic risks like volatility in the international stock markets.
Timing the market
Refrain from changing your portfolio to respond to market movements. “Timing” the markets is not a good idea in practice and can lead to missing potential gains.
Investors will experience market drops over the long term. It is a bad idea to panic and sell out the market when markets drop by a reasonable margin. This will only mean you have lost the money. It is important to remember why you invested and ensure your rationale has not changed. Investing is a long-term commitment, not a short-term win.
Dollar Cost Averaging
Another option for investors who are more cautious and hesitant about taking on long-term risks is to save regularly. This allows you to avoid trying to predict market movements.
This type of investing is known as “dollar cost averaging”. This method of investing involves regular drip-feeding money to units or shares regularly, rather than committing one large lump sum. It smooths market volatility.
Buy in less volatile markets to reduce the risk
Dollar-cost averaging works on acquiring more for your money when markets are low and acquiring less when markets are high. Equity-based investments are more common than fixed-income assets or bonds, which tend to be less volatile. This concept can be used for both regular monthly investing and spreading out the investment of large lump sums over a time period.
A gradual or regular investment can reduce the chance of investing on the wrong day and in market volatility – like we have been experiencing – and could allow investors to buy more units. This type of investing is more accurate if you consider it a series of lump sum investments. Each period, the entire contribution is invested. You can either use an automated phasing system or instruct the investor to change funds over a specified time period.
No matter the market, instilling investment discipline
To give you an example, one way to do this is with a lump sum that you’d prefer to invest gradually – for example, by taking $500,000 and investing $50,000 each month for ten months. Alternatively, you could dollar cost average on an open-ended basis by investing, say, $5,000 every month.
This principle allows you to invest regardless of the market. Dollar-cost averaging is a way for investors to limit their losses and instil a sense of investment discipline. It also ensures that investors buy at ever-lower prices when there are down markets.
Drip-feeding a lump sum investment into funds in regular amounts
Regular savings and investing are a great way to benefit from dollar cost averaging. It also helps keep a saving habit by committing to regular contributions. Investors looking to save each month will find it helpful.
This approach can be used by investors with a well-established portfolio to increase exposure to high-risk markets. This strategy is also suitable for lump-sum investors.
Many fund managers will allow you to drip-feed your lump sum investment into funds over time. You can spread your investment by making smaller monthly contributions, reducing the market volatility price.
Take advantage of market volatility by investing regularly in long-term savings
The trend of the developed stock market has been a steady and continuous rise in value over the long term, with occasional falls. You should not let global uncertainty affect your financial planning in the future. People who abandon their investment planning during market volatility or downturns can miss investment opportunities at lower rates.
The impact on global markets in the next months
In recent years, we’ve seen major events that cause global markets to drop, especially in the short-term, time and again. It doesn’t mean markets will not recover. So try not to be too worried.
History has shown that market fluctuations are part of investing. In the past, these changes have led to short-term corrections. Although this can not be promised. If you would like further information or to discuss your requirements after experiencing market volatility, please contact our partners at GSB Capital.
This information is based on our current understanding of tax legislation and regulations. The taxation rates, bases, and reliefs are subject to change. Investments and income may lose value. It is possible not to receive the amount you invested. Past performance is not an indicator of future performance.
Ross Whatnall is CEO and co-founder of GSB and a highly experienced private client director. Ross holds many insurance and investment management qualifications, including CISI, CII, LIBF and CFA. He started his career in private banking with HSBC in the UK before moving to the UAE in 2013 to focus on serving his private clients.