For a while now, there has been talk of a possible share market crash. Since the 2008 Global Financial Crisis, share markets have shown a strong upward trend, and we have forgotten what it’s like when returns are negative. In the long term, share prices are driven by fundamental, objective measures such as company profitability and economic growth. In the short term, prices are driven by fear and greed. When fear sets in, uninformed investors panic and sell, causing a downhill snowball effect.
Expected volatility is not a reason to sell a share portfolio or to refrain from investing. A little volatility is good. Without it, we don’t have opportunities to make good returns. There is no point trying to move out of the share market before a downturn and move back in before it picks up again. That’s because it is only obvious where the turning points are with the benefit of hind sight – and by then it is too late. It’s much better to go with the flow and trust in the fact that markets always recover over time.
Volatility is not something to be afraid of providing you follow two principles. The first principle is, your investment in shares must be diversified to reduce risk. The second principle is that you must match your investment strategy to your investment time frame. When investors lose money by investing in shares it is because one of these investment principles has been violated. The shorter your investment time frame, the less exposure you should have to shares to reduce your risk, and the longer your investment frame, the higher your exposure to shares should be to increase your return. Keep enough cash on hand to last you through the downturn and you won’t be forced to sell at a loss.
