Understanding how market volatility can create opportunities

As market conditions continue to rouse a sense of anxiety within financial markets, it is important to remember that change isn’t necessarily a bad thing.

Whilst the predicted volatility may be causing some investors to worry about their assets’ performance, it can also provide opportunities that do not necessarily exist in more stable environments. We explain how……

Investors with a low tolerance for risk would traditionally be drawn to safer assets classes, such as cash, whereas those with a higher tolerance may be drawn to other assets such as emerging markets, which are inherently riskier. So, whilst the investor with a lower risk profile may not benefit from the higher returns associated with riskier asset classes, their investment is less likely to suffer from losses. Or is it?

If you are a long-term investor who needs to grow their wealth by inflation or higher then, in fact, cash isn’t a ‘low-risk’ investment at all. With interest rates sitting low and the impact that inflation has on the time value of money, £1 in your pocket today is almost certainly going to be worth less in the future.

As inflation increases the prices of good and services over time, it effectively decreases the amount of goods and services we can buy with that £1. And if wages remain the same as inflation continues to rise, it will take more of our money to purchase the same goods and services in the future. In this instance, it would therefore prove more beneficial for a cash-rich investor with a long-term view to invest some of their savings in more volatile assets in order to increase their chances of achieving an over-inflation return.

Volatility in the market can also open opportunities for investors who may not have previously considered certain asset classes when prices were higher. Quite simply, when asset prices fall, it makes them more attractive and allows investors to rebalance their portfolios in new ways.

Where investors have a low tolerance to risk, it is also possible to take out protection strategies at a low cost; so rather than trying to predict the outcome, investors can instead protect their portfolio against short-term volatility and move away from more familiar assets classes.

While investors are moving towards a more nuanced understanding of risk, it remains that we are all individuals with different motivations and attitudes to how we invest our money. However, whether a seasoned investor or new to the market, we can all make choices based on instinct rather than analysis. To assume that the future will behave like the past is a human trait but rarely the way things play out. To better understand how we make our financial decisions, we need to understand how we approach risk and what kind of investor personality we are. Without knowing it, we are all subject to biases and prejudices, many of which are unseen and a function of our subconscious.

As mentioned in our previous article, at Finura, we commit time to understanding the behavioural thoughts, feelings and emotions that drive our client’s financial decision making. One part of this process is to ask our clients to take a quick survey called investIQ, which was developed by Schroders. The idea is to help you understand the basis from which you make important decisions, including those relating to how you invest your money; is it instinct, logic or following the crowd?

Developed by behavioural scientists, investIQ highlights which behavioural traits influence you the most and provides advice on how best to deal with them. Does the pain of losing affect you more than the pleasure of winning? Are you overly influenced by your fear of making the wrong choice? Do you favour immediate rewards at the expense of your long-term goals? InvestIQ can help you to answer all these questions and more, which in turn helps your adviser to recommend investments that sit more comfortably with you as an individual.

If you’d like some advice on how volatility could present new opportunities for your portfolio, or to take the investIQ test, please contact your Finura adviser.

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Past performance is not a guide to future performance and may not be repeated. Capital is at risk; investments and the income from them can fall as well as rise and investors may not get back the amounts originally invested.

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Sources:
https://www.financiallibrary.co.uk/abstract/volatility-create-opportunities-29528
http://www.schroders.com/en/uk/private-investor/a-guide-to-investing/investiq/behaviour-hub/