There are many financial instruments that attract varying returns and risks. There are the traditional saving investments that usually offer you a steady return irrespective of market fluctuations. There are also instruments that contain an element of risk as they depend on the market for providing returns.
If you are a conservative investor you would invest in traditional instruments and the markets are not for you based on your risk appetite. But, if you are a risk taker then investing in equity is the most obvious avenue for your investments.
The moment you invest in equities then you face volatility. Prices fluctuate in stock markets because of supply and demand. When demand for equity is high and supply is low more people want to buy and prices rise. On the other hand, when supply for equity is high and demand is low more people want to sell and prices fall. Demand and supply are dynamic and not static. They fluctuate and so do prices giving rise to volatility.
Imagine the markets without volatility. There is no upward or downward movement of prices and your investment is safe but without any returns. So, the first thing you must realize is that volatility is a characteristic of markets.
Unfortunately, many investors misunderstand volatility. Their misunderstanding leads to decisions which are detrimental to their investments. Typically, they sell when prices go down only to rue when prices climb back up. Sometimes, these investors commit the mistake of reentering the market at a higher price and when prices fall again they tend to sell thus losing more money. This usually happens due to poor knowledge of the investor, an investor is thus suggested to consult the financial advisor.
Volatility is a double-edged sword. If you do not understand it you tend to lose money. But, if you understand it then you probably don’t fear it and then you aim to make it work for you to give you potential returns.
Here are some ways on how to help you make volatility work for you.
There are various factors that determine the price of equities on the markets. Supply and demand for the equity is a function of the fundamental performance of the company. People invest in the future potential of the company and the cumulative view of investors in a company is another factor that determines the price of the equity of the company. Thus, the price of companies are different and their prices are subject to different volatilities.
Diversification, investing in many companies, of your investment portfolio is a good way to handle volatility.
Keep emotion in check
Emotions play an important role in market investments. Investors think that they are smart and they think that they always buy at the lowest price and sell at the highest price – they profess expertise in timing the market. Unfortunately, no one can predict the market prices and that is why there is volatility. You tend to buy when everyone is buying which means that the price is going up and so you end up buying at the high price. Similarly, you end up selling when everyone is selling and you end up selling at the low price. Thus, you need to keep your emotions in check and not react to market fluctuations as long as your long-term goal for your investment is intact.
Keeping emotion out of buy or sell decisions is another good way to handle volatility. If you can keep your emotion in check you can overcome the ‘timing the market’ syndrome.
Since historical data show that timing the market is not a good option for investing, the rupee-cost averaging method of buying helps overcome volatility. In the rupee-cost averaging method, a mode to invest is through a systematic investment plan (SIP), you invest a fixed amount of money in a particular mutual fund scheme consistently on a fixed date on a daily or weekly or monthly basis based on the defined frequency opted by the investor. This helps to lower the effect of volatility on your investments. Here too, historical data show that your average cost of purchase of equity is lower than if you were to time the market.
SIP is one of the ways to handle volatility because it aims to smoothen out your investment.
Rebalance your portfolio
Since diversification of your portfolio is a good way to handle volatility it is incumbent upon you to periodically assess your allocations within the portfolio. It is possible that some equities are performing well and others not. So, a periodic assessment helps to bring focus on to your investment goals. You may use volatility to rebalance your portfolio.
From the above, it is clear that volatility is a part and parcel of markets.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.