Understanding market volatility

Markets are influenced by many things – industrial, economic, political and social factors can all have an impact. For example, consumer and business confidence affect spending and therefore company profits. Global trade and production naturally affect economic growth.

Poor political and fiscal decisions in some countries may lead to a flow-on effect in other countries who are owed money. And of course, natural disasters can cause major damage to any economy with no warning. During times of market volatility, it’s important to remember one of the fundamental principles of investing – markets move in cycles.

In times of market volatility your super balance may decline, but it is important to remember that markets move in cycles. Volatility is a natural part of the economic cycle. Markets are influenced by a range of factors and are inherently unpredictable.

The Australian Securities & Investments Commission (ASIC) states that, 'negative returns from time to time are not inconsistent with successful long term investment'.1 History demonstrates that over the long-term, the general trend of share markets has been upward.

"The timeframe for super may be 20 years or more, so short term volatility shouldn't diminish the long term potential of your investments."

Super is a long-term investment. Shares, which usually form a large part of most balanced super accounts, are also generally a long-term investment. They are designed to provide capital growth over a period of five years or more. Think in years, not days.

The time frame for super may be 20 years or more, so short term volatility shouldn't diminish the long-term potential of your investments. Growth assets (such as shares) tend to fluctuate in the short-term, but have historically provided excellent returns for investors over the long-term.

When sharemarkets fall in value, it may be tempting to sell up. However, trying to time the market by selling now and buying back later is a risky strategy that rarely results in investors coming out ahead. By taking a long-term view of investing, you can ride out any short-term fluctuations in the market and take advantage of growth opportunities over the long-term.

Diversification is one of the most effective ways of managing volatility. It can help deliver smoother, more consistent results over time. Your investment may benefit by being spread across a variety of asset classes, including shares (domestic and global), fixed income, cash, direct and listed property and alternatives.

This diversification should help soften the effects of any sharemarket falls as some asset classes often tend to do well whilst others are struggling. Also, spreading your assets around means you are less reliant on any one asset class at any particular time.

All investments carry some risk. How much risk you’re willing to accept will be influenced by your financial situation, family considerations, time horizon and even your personality. If market volatility has caused you to reassess the way you feel about risk, it’s important that you see your financial adviser to discuss any necessary changes to your financial plan.

Before you withdraw from an investment you should understand all the implications, risks and costs involved.

• Locking in your losses. If the value of your investment is falling, you are technically only making a loss on paper. A rise in prices could soon return your investment to profit without you doing anything. Selling your investment makes any losses real and irreversible.
• Incurring capital gains tax (CGT). Make sure you know what your CGT position will be before selling any asset.
• Losing the benefits of compounding. If you’re thinking about making a partial withdrawal from an investment, remember that it’s not just the withdrawal you lose, but all future earnings and interest on that amount.