Volatility: Often The Spark To Investor Fear

Fear. It can do funny things to investors. When the stock market goes down significantly, people sometimes start to panic. People begin to act in a way they know they shouldn’t, but emotion sets in and rational thinking can be hard. It can be very difficult sometimes not to act rashly when fear and emotion sets in. But the worst thing you can do is panic-sell, because you’ll often regret the decisions you make at that time.

What Sparks The Fear?

Surprisingly, it’s not necessarily the fact that the market or an investment is down that sparks fear in investors. It’s often the volatility associated with it—the rollercoaster ride of ups and downs of the market and the unpredictability—that shakes investors. This can generate fear, particularly if it happens over a longer period of time.

Volatility is actually something that is around all the time in the markets, but most people don’t notice it when the peaks and valleys are small. However, when the peaks and valleys become more pronounced, fear can take hold. This is certainly something we saw at the beginning of 2016 when the markets were off to a rough start. There was a week in mid February where the market was up 800 points followed by another week when it was down a little under 800 points. Those kinds of swings can leave investors feeling very uncertain and unsettled.

How Can You Avoid Falling Into The Traps?

The first thing you need to do when the stock market falls significantly is take a step back and not panic. Call your investment advisor to see if what’s going on in the markets actually affects your investments. It may be that your investments are not in areas that are being negatively impacted and an advisor can offer sober second thoughts.

Look for opportunities. In turbulent times, you can often buy investments ‘on the cheap’, which means looking for good quality investments at an inexpensive price. If you have investments that are not doing well, you have to assess them to make sure that the reasons for owning them are still intact. If they are, perhaps you buy more at the current (cheaper) price. If the story has changed regarding the investments you own, then those are the investments you want to get out of to move into other areas that you think will perform better in the future.

Consider subtle changes to your portfolio. In volatile times, you can often make subtle changes within the portfolio to try to move money to areas that have a good story behind them. In my opinion, you want to avoid making big trades that involve timing the markets. I would rather make small changes but stay in the market than to try to time the markets by getting out of investments and then consequently go back in when you feel times look better.

Have a plan. Having a plan always helps. I believe that the days of the buy-and-hold strategy are long gone. The markets are too volatile today to just hold an investment and expect you will always make money over time. If you look at the performance of the Dow Jones Industrial Average from 2000 to 2010 – a span of 10 years – you’ll notice that the Dow passed the 10,000 point mark at least six times. Investors who were passive during this period would have seen very little positive results. They would have been flat or just marginally higher because the index didn't move much higher over that 10-year period.

By contrast, active investors could have seen much better results. If investors bought quality investments and then set price targets of when to sell, they could have done very well. By selling part or all of their investments when they reached their targets, investors would have gains and have locked in their profits before the market pulled back.

And that’s the key: set targets for investments and when the targets are reached, re-evaluate your strategy. Decide if it’s the time to sell some or all of it or, in some cases, add even more, if the investment is doing well and looks like it will have a continued upside.

Sitting Out The Market Can Create Challenges

When markets become highly volatile and investors get scared, some investors choose to step away completely and sit on the sidelines until the markets pick up. It can be a natural response to get away from the turbulence, but the challenge for those who chose to sit out becomes knowing when to get back into the market. In essence, investors find themselves trying to time the market – knowing when an investment has reached its low point and getting back in. This is extremely difficult to achieve.

Most people wait until they see the market recovering and get back in too late, re-entering when investments have already made some significant gains. Consequently, they miss the initial part of the rebound and their returns aren’t as strong as they could be.

It’s often better to stay in the market and follow an active investing strategy so that you can realize the benefits of the initial rebounds. With some careful investing, you can use the volatility to purchase investments that previously might have been too expensive, but now have become a better value as a result of drops in the market.

Allan Small is the Senior Investment Advisor with Allan Small Financial Group with HollisWealth, a Division of Scotia Capital Inc. as well as the author of How To Profit When Investors Are Scared.

This article was prepared solely by Allan Small, registered representative of HollisWealth ® (a division of Scotia Capital Inc., a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada). The views, including recommendations expressed in this article are those of Allan Small and not those of HollisWealth. ® Registered Trademark of The Bank of Nova Scotia, used under license. Allan Small Financial Group is a personal trade name of Allan Small.