How to stay calm when markets get bumpy

How should you react to bumpy stock markets? Is it best to withdraw every penny, move into assets that are less affected, or shut your eyes and hope for the best?

It’s important to understand that some degree of volatility is an unavoidable part of investing life. Even professionals with years of experience aren’t immune. But while such periods are unsettling, they don’t automatically require dramatic changes to your portfolio – as long as it’s been constructed correctly.

Here, we look at safeguarding it from tricky times, the funds that can give you confidence, and how you should respond when markets are challenging.

Overview

Global stock markets can easily move between 15% and 20% in any given year. Sometimes it will be a lot less, and at other times significantly more. Geopolitical problems, economic instability, sector-specific problems and individual company results can all have a bearing on particular indices.

The general rule for investors is not to overreact. Investment decisions are best made in a cold, dispassionate way, as opposed to being fuelled by panic. In fact, your response to such problems should already be in place – well before the markets start showing any signs of volatility.

If you’d like to build confidence in how to handle volatility, consider signing up for FundCalibre’s Demystifying Investments course, where you can learn these principles step by step.

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Our five-point guide illustrates this point:

• Understand your goals
• Have a diversified portfolio 
• Consider weather-proof funds
• Analyse the turbulence
• Pound-cost averaging

1. Understand your goals

You must prepare for potential stock market turbulence in advance by being clear with your financial objectives and attitude to risk. Why are you investing? Do you need the money for a specific goal, or are you building a nest egg? What would be the impact if you ended up losing everything?

Your goals, the amount of wealth tied up in stock market investments, and the time until those goals are realised will all influence how you respond to volatility. If you have decades to go before retirement, for example, short-term market swings are unlikely to matter, as there is ample time for investments to recover their value. On the other hand, if you need the money in just a few years for something like a house purchase, sudden volatility could have a far greater impact on your plans.

2. Have a diversified portfolio

It makes sense to embrace diversification by holding a variety of assets within your portfolio that have different risk/return profiles. The concept is that any losses suffered in one area of your portfolio will be countered by gains elsewhere. Should equities fall, for example, hopefully property will rise.

Diversification could mean having exposure to equities, bonds, property, and commodities, rather than running a higher risk by focusing on just one area. You can also diversify within asset classes – as in large and small companies – as well as across different countries and geographies.

3. Consider weather-proof funds

The good news is that you can weather-proof your overall portfolio by choosing the most suitable combination of investment funds for your needs. If you select the most appropriate funds, you should be able to let the managers focus on the job of buying and selling various holdings.

For example, Orbis Global Cautious, managed by Alec Cutler, contains a mix of equities, fixed income and commodity-linked holdings. It’s in the IA Mixed Investment 20-60% Shares, which means it’s limited to a maximum of 60% in equities, making it attractively diversified.

For those seeking a higher potential allocation to equities, the BNY Mellon Multi-Asset Income fund is worth considering. It sits in the IA Mixed Investment 40-85% Shares sector. We like how the fund combines Newton’s global investment themes with carrying out rigorous fundamental analysis. It’s been a consistently strong performer over the past decade.

There is also a new breed of volatility-managed funds that target a certain level of risk and then look to maximise returns. One such option is Rathbone Strategic Growth Portfolio. This fund, which has a target of cash plus 3-5% per annum over a minimum five-year period, invests in equities, government bonds, alternative strategies, corporate bonds and other asset classes. The team, led by the experienced David Coombs, focuses on risk and correlation of assets as part of its overall investment process.

As we mentioned, downturns in particular areas can provide opportunities. For example, if technology stocks took a tumble, then you may decide to get involved when valuations are cheap. In that case, an option could be buying into a fund such as Allianz Technology Trust. Michael Seidenberg, its manager, focuses on building a diversified portfolio of tech stocks. He considers themes that address the major growth trends and could be well-placed to benefit in this fictional scenario by holding companies that are most likely to recover strongly.

4. Analyse the turbulence

With everything we’ve said, it’s always sensible to calmly explore the reasons for the volatility and decide if it’s purely short-term turbulence or a longer-term issue. The downturn due to COVID-19 is a prime example. The S&P 500 Index plummeted by more than 30% in March 2020 – but had recovered much of these losses within three months*. Of course, a market slump doesn’t have to be a negative. Significant falls in share prices can actually present buying opportunities – and the prospect of a bumper profit when they eventually recover.

5. Pound cost averaging

A good way to take the stress out of trying to time the stock market is a financial technique known as pound cost averaging. The idea is to smooth out returns by regular investing. It works by investing a set amount of money each month to buy units of a fund at whatever price they happen to be at that point. When they fall in price, you can buy more, and vice versa.

For example, if you’ve been buying units at a rate of £6 each, and the price drops to £3, you’ll be getting more for the same amount of money. This concept encourages investors to remove emotion from their decision making and avoid making knee-jerk reactions to market changes.

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*Source: McKinsey & Company, 1 December 2020