Market turbulence occurs when the stock market suddenly, and unexpectedly, rises and falls within a short space of time. It can be highly disconcerting for investors who have their assets tied up with these stocks, especially when these decline in value.
In such times, there is often a strong emotional and social pressure to pull out of the market, before things get any worse. However, in most cases converting your assets into cash actually just serves to make a temporary loss into a permanent one.
Why Market Turbulence Occurs
Explaining rises and falls in the stock market is a bit like trying to explain the weather. Just as it is in the physical stratosphere, there are multitudes of factors all exerting their influence on the market all at the same time.
These factors are often difficult to identify and predict but might include influences such as geopolitical upheaval or change. The immediate aftermath of the 2016 Brexit vote, for instance, brought a lot of downward movement in the market due to the uncertainty suddenly brought into the picture.
Other factors might be new government policies, such as new taxes to capital gains or dividends. Whatever the exact cause of market turbulence, it is important to recognise that this behaviour is part and parcel of investing. No one can fully predict what will happen in the future, which means it is unwise to try and “time the market” with your investments.
Market Dips Can Be Your Friend
It is easy to see downward movement in the stock market as something negative, from an investment point of view. However, this does not necessarily need to be the case. In fact, it can be an opportunity to make you financially better off!
Consider, for instance, that some of the best returns investors saw in the US stock market occurred during the Great Depression in the 1930s. Indeed, remember that when your shares decline in value you end up buying more for the same amount of money, if you continue to regularly invest in them. This means should the stock market eventually rise again, you will actually have made a greater investment return.
This goes to show the importance of taking a long-term view with your investments. If you see investing as a quick way to make money, then you are really treading in the territory of gambling rather than sensible investing. You need to be thinking in terms of 5, 10, 15 years or more – during which time there will likely be many dips in your investment. Overall, however, their value will rise over time.
There is an important note to make here concerning debt. Stock market dips can be seen positively for investors with financial flexibility and cash reserves. However, those who invest with debt are generally setting themselves up for a lot of headaches and potential loss.
For instance, consider the 2008 financial crisis. Many investors wished they had more money to invest when the crisis started to unfold. Very few people, however, looked back afterwards wishing they had borrowed money to invest in stocks in 2007.
Tips for Weathering Market Turbulence
Whilst the above might provide some perspective for those worried by dips in their investments, or excited by bull markets, we understand it can be difficult to keep a level head. Our emotions often pressure us to take over and lead us to impulsive investment decisions which we often later regret. In light of this, here are some of our top tips for dealing with market turbulence:
#1 Know your risk tolerance
Some investors fancy themselves as huge risk-takers, going after the big wins. Whilst some people are like that, many people simply do not have the stomach for the risk that this entails. Psychology, in other words, is immensely important in the world of investing. If you have a lower tolerance to risk, then you need to factor this in when constructing your investment portfolio.
Your attitude towards investment risk might change over time. For instance, it might be that as you start investing and come to understand it more, your tolerance for higher-risk investments increases. Or, perhaps as you grow old and look to retire, growing your investment portfolio is less important than preserving your wealth in order to give you a comfortable retirement.
Regardless of whether/how your attitude changes, it is important to work with an experienced financial adviser to help you make any necessary adjustments to your investment portfolio.
#2 Keep a handle on your emotions
Your emotions are probably the biggest hindrance to your making sensible investment decisions. For instance, fear over your investments falling in value – and perhaps disappearing entirely – can lead you to sell during market dips, which is usually a very bad idea. If history is any guide, market indexes tend to recover from and surpass their declines.
At the same time, investing lots of money in a “hot stock” can also be a terrible idea. Everyone might be talking about it, and pouring their money in. it can be immensely difficult to stop yourself from jumping on the bandwagon.
However, you need to keep a level head and retain a sense of perspective. Just because lots of people are convinced a particular stock will succeed and make them lots of money, does not mean this will happen.
This is one of the mantras of financial advisers and many successful investors: “Do not put all your eggs in one basket.” For instance, if you put all of your investment money into one company and then that company fails, you stand to lose all of your money.
If, however, you invest in multiple companies – perhaps in different industries and countries – then you minimise any potential losses in the event that some of the stocks fall.
It is worth noting that at Cedar House, we guide our clients towards investing in portfolios which are not simply diversified in the stocks they invest in. They are also diversified in terms of asset classes.
For instance, a portfolio might have investments in stocks, bonds, property and cash to varying degrees – depending on the needs, goals and financial means of the client. Some asset classes (e.g. bonds) and less risky, and can act as a “buffer” in the event that your stock investments fall in value.