Market Volatility: Friend or Foe?

Are you the type of investor who gets worried or panics whenever the stock market drops by three percent a day? If you are, it is time you stop looking at your investment portfolio on a daily basis. After all, investment fortunes are made over the long run and not overnight.
Wouldn’t investing be so much easier if the stock market moved according to a strict set of agreed rules or guidelines over time? For example, imagine if prices rose in the first week of every month, remained steady for another week, before gradually falling back to the previous levels as shown in the diagram below.
January February March April
With this knowledge in mind, you can probably buy during the period of low prices and sell at higher levels. Repeating this process every month should provide you with ever-increasing wealth as long as your buying and selling does not affect the hypothetical market gyrations.
Unfortunately, markets do not follow these patterns in reality. Attempting to ‘time’ buying and selling decisions in the short-term is risky, and something that very few professional investors manage to do successfully on a regular basis. This is because markets are unpredictable – they can rise gradually over a number of days before suddenly falling and losing the previous gains. Unexpected news, either specific to one company or the economy as a whole, can significantly influence stock prices in the short-term. Psychological factors such as changes in risk appetite due to fear or greed can also affect markets over the short-term. In the chart below, you can see the volatility of the FBM KLCI Index over the past 20 years.
FBM KLCI Index (1 April 1990 - 31 March 2010)2004006008001000120014001600Mar-90Mar-92Mar-94Mar-96Mar-98Mar-00Mar-02Mar-04Mar-06Mar-08Mar-10
Source: Lipper, April 2010.
Looking Past Short-Term Volatility for Long-Term Gains
Over the long-term, equities and real estate have generally outperformed both bonds and money markets. However, unlike real estate, equity prices may experience extreme volatility over the short-term. During these uncertain periods, it is normal for most investors to be anxious and worried about the value of their investments.
Due to the volatility in the markets, many experts advise investors to take a long-term view for their investments. This is because a longer time frame is needed for companies to grow their businesses. In addition, research shows that, historically, the longer you stay invested, the less likely you will lose money and the higher the possibility of making a profit. Profits of well-managed companies will continue to grow with time and be able to withstand short-term periods of cyclical weaknesses.
Market Volatility Presents Investment Opportunities
American billionaire Warren Buffett is commonly referred to as the world’s most successful investor. For over 50 years, Buffett has continued to grow his fortune – not through complex strategies or a magic formula, but by adhering to basic investment principles in a disciplined manner.
When the U.S. stock market fell following the ill-fated technology boom of the 1990s, many investors were selling their holdings in fear or watching nervously from the sidelines. On the other hand, Buffett applied the golden rule of investing – buy when prices are low – and quietly went about accumulating over-sold ‘cheap’ stocks in a number of stable, quality companies such as Gillette and Coca-Cola.
The market soon realised that quality blue-chip firms in bricks-and-mortars businesses were unaffected by the technology crash and were still making sustainable profits. As such, they quickly returned to their previous valuations. After hitting a 5-year low of 7,286 points in October 2002, the U.S. Dow Jones Industrial Average Index rebounded by more than 40 percent by the end of 2003. Buffett, having selected better stocks than the market average, performed even better.
Therefore, in the current market volatility, think rationally and keep your emotions in check. As long as you have a long-term horizon, view the short-term weakness as a potential opportunity for investing at attractive prices.
Adopting Ringgit-Cost Averaging
In volatile market conditions, investors should consider Ringgit-cost averaging (RCA) for their investments. This technique works by investing a fixed amount of money in regular intervals, regardless of how the market is performing. It is a disciplined approach whereby investors invest no matter how the market is doing, thus helping to avoid the poor decisions most people make when trying to time the market
When the markets are down, many people become fearful and reluctant to invest. That may help avoid some losses in the short-term. However, when markets eventually rebound, individuals who have avoided investing because of the earlier volatility will miss out on the gains. Those who invest a fixed amount every month, on the other hand, will be positioned to benefit when the market bounces back as they would have invested at bargain prices.
The Folly of Market Timing
During periods of market volatility, investors might be tempted to delay making investment decisions or sell existing holdings in the hope of buying back in when prices are lower. Ideally, market timing seems to be an attractive method of investing but it seldom works in practice. Just as sharp falls in stock markets tend to occur over short periods of time, the best gains are similarly concentrated. Because these gains often occur just after a market decline, an investor who tries to avoid falls is likely to miss the best gains.