Three investment lessons from recent volatility

Over the last twelve months, investors have been buffeted by a lot of volatility, particularly in the share market. Australian shares alone fell 15 per cent from their August highs last year before rallying strongly.

That volatility has no doubt disconcerted investors. When markets go down the paper value of their investments fall. Obviously, investors don’t want to see that happen.

But despite the difficulty of riding out increased volatility, investors need to remember three key points that will help them navigate similar periods in the future.

1. Normal noise

The first point is that volatility is normal. Sometimes we go through really calm years like 2017 - but 2017 was a bit of an aberration. Historically, it’s quite normal to have 10 per cent falls, 20 per cent falls, and sometimes even deeper falls like we saw during the global financial crisis. Australian shares have negative returns in roughly two years out of every ten.

In fact, volatility – the movement up and down in the value of your share market investment – is the price we pay to get higher returns from shares than, say, bank deposits. If shares just moved in a straight line, the rate of return would be similar to bank deposits, two per cent or so. (Since 1900, Australian shares have returned 11.7 per cent and US shares 9.8 per cent.)

Volatility is just part and parcel of investing in shares.

2. Not real losses

The second point is that you only suffer a real loss if you sell your shares when the market falls. Otherwise it’s just a paper loss.

So try and avoid panicking and selling out of the market at the wrong time when markets have come down.

3. Opportunities

The third point is that volatility provides opportunity. When markets fall it means shares are cheaper. That’s usually a good time to buy shares. It’s a far better time to buy the Australian share market when it’s down around 5400 than when it’s around 6300.

The reality is that most people prefer to buy when markets are up (as that is when their confidence is up to) rather than when they’re down.

One way to overcome that uncertainty is to average into the market over time because you never know precisely when the market’s going to bottom. For example, you might have $10,000 and buy shares in parcels of $2,500 over the next four months.

A positive outlook

While late 2018 was tough for investors, the fact is that volatility is likely to continue to remain high in 2019, with potential triggers including the ongoing trade conflicts and still soft economic indicators globally.

But at the same time, the outlook is positive for markets in 2019. Globally, central banks and policy makers are looking to stimulate their economies, we’re likely to see some sort of resolution of the US-China trade dispute, and the US economy is still growing solidly.

But if investors are to benefit from the higher returns shares provide over long periods, they’re going to have to learn to accept the inevitable volatility the stock market will throw up.