Article provided by Dynamic Funds
The notion of investing in the stock market without volatility is as illusory as a car without an engine. Like it or not, the two concepts invariably go hand in hand.
But does that mean you should avoid volatility – and investing – altogether? The short answer is no. Market uncertainty can naturally cause panic and lead to poor investment decisions. Yet, by recognizing short-term market uncertainty for what it is, you can help ensure that it doesn’t derail your long-term goals.
Here are five tried-and-tested principles that can help you gain needed perspective.
1. Keep calm and carry on
Investors generally feel a financial loss about two and a half times more than a gain of the same magnitude. Understandably, many of us experience a roller coaster of emotions when investing (as the diagram below illustrates), which can translate into poor buy and sell decisions. Being aware of these emotions during periods of increased volatility can help you avoid panic, keep calm, remain disciplined and focused on reaching your long-term goals.
2. Stay invested…it’s time, not timing
Trying to time the ups and downs of the market is a bit like the roll of a dice. Consider the impact of missing the best 10, 20 and 30 days on the value of $10,000 invested in Canadian stocks over the past 10 years. As the illustration below shows, sitting on the sidelines can be costly. Over a 10-year period, if you’re out of the market for even a small number of days when the market is outperforming, you can substantially reduce your return potential. Staying invested – while not always easy – can potentially translate into a better outcome.
3. Manage risk, don’t avoid it
Risk can be a loaded term when it comes to investing and is often misunderstood. You often hear about risk and volatility in investment parlance, the two concepts are related but are not the same thing. Risk refers to the degree of uncertainty and/or potential financial loss inherent in an investment decision. On the other hand, volatility simply measures how much the return of an investment or the broader market fluctuates up and down. While some may fixate on these fluctuations, the permanent loss of capital should be of greater concern. Reducing exposure to securities that are perceived as ‘risky’ will certainly lower market risk, but by doing so, long-term investors could potentially see the purchasing power of their savings erode faster and outlive their savings quicker. Whether we like it or not, investing in the stock market and risk are a package deal. The key to long-term success is to manage your exposure to risk by using time and diversification to your advantage
4. Put diversification to work
Often equated to not putting all your eggs in one basket, diversification is a tried-and-tested technique that combines different types of investments in a portfolio to lower risk. No single asset class is consistently among the top performers, and the best and worst performers can change from one year to the next. By including investments that are less correlated to one another – or react differently to economic and market events – gains in some can help offset losses in others.
5. Take Advantage of Dollar-Cost Averaging
Dollar-cost averaging is an investment method used to help reduce the risk of timing a lump-sum investment. By investing a fixed dollar amount on a regular basis, the “dollar-cost averaging” (DCA) process helps control the effect of market volatility by smoothing out the average cost per unit of mutual funds purchased. Over time, and in certain market conditions, it could result in a lower average cost and a higher return. The graph (below) illustrates how a dollar-cost-averaging strategy compares to a lump sum purchase in 2020, a period punctuated by extreme market volatility and a significant correction. While it’s important to note that DCA doesn’t always produce a higher return versus lump sum investing, this systematic approach can help investors stay the course by taking the guesswork out of when to invest.
The Value of Advice
This document was prepared by the Investment Products & Platforms Team. The opinions expressed in this document do not necessarily reflect the opinions of iA Private Wealth Inc. The comments contained herein are a general discussion of certain issues intended as general information only and should not be relied upon as tax or legal advice. Please obtain independent professional advice, in the context of your particular circumstances. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any securities. Contents copyright by the publishers. The information contained herein may not apply to all types of investors.
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