All investments carry a degree of risk, and every investor has a different comfort level in terms of how much risk they’re willing to take on. Many factors come into play – from the investor’s financial situation and investment timeframe to their lifestyle goals and even their personality.
So it’s hardly surprising that investors react differently when markets fall. Some of us are quick to sell up while others are willing to ride out short-term fluctuations by keeping an eye on the long-term prize.
But when markets are volatile, how do you know if it’s time to change your strategy?
How do investors react to volatility?
A study by Colonial First State Global Asset Management (GAM)1 examined investor sentiment during a period of volatility in 2016, and how it impacted their investment decisions.
The results showed that as confidence declined, portfolio activity increased as more investors moved away from the share market. In fact, the group most likely to switch out of shares were investors aged 50 and over. This is perhaps because they were seeking to preserve their capital and minimise their risk exposure as they headed towards retirement.
While investors of all ages often respond to uncertainty in the market by taking a more active approach to their investments, this may not always work in their best interests. Not only is switching costly, but it can also mean missing out on opportunities when the market recovers.
Should you switch your investments?
Before you withdraw from an investment, it’s important to make sure you understand all the implications, including the risks and costs involved. For one thing, if you sell your asset you may be liable for capital gains tax (CGT), which can reduce the profit you stand to make.
But that’s not all: if the value of your investment is falling, this is only a hypothetical or “on paper” loss. Once share prices begin to rise again, your investment could soon return to profit without you doing anything. However, if you sell your investment while its value is down, you essentially crystallise your losses – making them real and irreversible.
What’s more, even if you’re only planning to sell off part of an investment, it’s not just the face value you’ll be giving up. You’ll also miss out on the benefits of compounding, which means you won’t be able to earn further returns on the shares you sell.
Before you withdraw from an investment, it’s important to make sure you understand all the implications, including the risks and costs involved.
What other strategies are there?
When tailoring your investment mix, it’s important to focus on the big picture and think long term. That way, you may be able to ride out short-term fluctuations and take advantage of growth opportunities.
Diversification should also be a key part of any long-term investment strategy. GAM’s research revealed that Australian investors tend to react to uncertainty overseas by reducing their exposure to international shares. But while this may seem like a sensible move in theory, it also means your overall portfolio will become dependent on a smaller pool of asset classes.
On the other hand, a diverse portfolio allows you to spread your risk exposure across different asset classes and markets, rather than putting all your eggs in one basket. This provides a financial buffer whenever an individual asset class declines in value.
If you’re thinking about changing your investment strategy, your financial adviser should be your first port of call. They can review your portfolio to make sure you have the right investment mix, taking into account your financial goals, investment timeframe and risk appetite.
You can learn more here about how to reduce the impact of market movements.
1 Investor Insights, Global Asset Management, December 2016.
This document has been prepared by Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State). The information, opinions, and commentary contained in this document have been sourced from Global Markets Research, a division of Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945. Global Markets Research has given Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) its permission to reproduce its information, opinions, and commentary contained in this document and for Colonial First State to authorise third parties to reproduce this document. This document has been prepared for general information purposes only and is intended to provide a summary of the subject matter covered. It does not purport to be comprehensive or to give advice. The views expressed are the views of Colonial First State at the time of writing and may change over time. This document does not constitute an offer, invitation, investment recommendation or inducement to acquire, hold, vary, or dispose of any financial products. Colonial First State is a wholly owned subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124, AFS Licence 234945 (the Bank). Colonial First State is the issuer of super, pension and investment products. The Bank and its subsidiaries do not guarantee the performance of Colonial First State’s products or the repayment of capital for investments. This document may include general advice but does not take into account your individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement (PDS) and Financial Services Guide (FSG) carefully and assess whether the information is appropriate for you and consider talking to a financial adviser before making an investment decision. The PDS and FSG can be obtained from colonialfirststate.com.au or by calling us on 13 13 36. Past performance is no indication of future performance. Stocks mentioned are for illustrative purposes only and are not recommendations to you to buy sell or hold these stocks. This document cannot be used or copied in whole or part without Colonial First State’s express written consent. Copyright © Commonwealth Bank of Australia 2019