Keep calm amid volatile markets to protect your assets
In recent times low oil prices, market volatility and the start of the quantitative easing programme in Europe have come about. UAE and GCC markets have experienced volatile movements in both directions over a short period. And there has been plenty of reporting (often contrary) on the value of homes in the region.
All of this can make us feel anxious. The markets can be affected by numerous factors, and sometimes we simply do not see events coming. Investors are twice as likely to react to a fall in value as they are to an increase in the value of their holdings, and markets drop twice as fast as they rise. This makes an interesting case for a lesson in how to behave during market volatility.
The biggest gains or losses in markets happen in single-day transactions. It is important not to sell a position as a reaction, as often the event you are reacting to is over, and sometimes markets overreact then correct back to normal. It is highly possible to exit after a fall then miss a gain, compounding and crystallising a loss. As a private investor, here are five easy steps to follow to avoid irrational behaviour:
Take a long-term view
Volatility in the stock markets has a typical cycle of five to 10 years. When investing, set a milestone date for each investment. Put this in the diary and ignore any movement before this date. Only allocate a small part of a portfolio to sector-specific investments, as this carries more risk and will, as a rule, be more volatile. If you allocate money locally, remember the UAE is an emerging market, and a small one at that. Just because you live somewhere, do not get too hooked on the bubble you are in. This creates extra risk and instability.
Avoid investing in overvalued portfolios
Past performance is never a guarantee of future success. When an investment has done well, that performance is not necessarily a trigger to buy that investment. This was certainly true of local residents buying property in 2007, and later stocks in the local market off the back of the upwards performance in 2012-13. With equities, the price-to-earnings ratio should be considered. A higher ratio indicates overvalued stock. The consistency of dividend payments is also an important factor; the more stable companies are usually quite consistent with dividend payments. Drip-feeding your investment into the market minimises the risk of investing at the wrong time and creates an average purchase price.
Sometimes even the professionals get it wrong. For instance, one of the world’s greatest investors, Warren Buffett, has a reputation for taking long-term views on established companies rather than investing in riskier stocks. He recently admitted making a mistake by backing Tesco, and his Berkshire Hathaway investment company sold 245 million shares in the supermarket giant at a massive loss.
As a private investor, it is advisable to spread your investment across a diversified range of funds, shares, territories, sectors and currencies to reduce exposure to individual holdings. This hedges against market movements and can lessen the effect on your portfolio if a fund or sector performs poorly.
Identify hot spots
Understand what is growing and why. Certain asset classes negatively correlate for obvious reasons, and sometimes trends are very easy to spot. With this knowledge, invest a small percentage in these growth areas through an expert. Remember, if it can grow quickly it can also fall faster, so do not go overweight and spread your risk. The more difficult the investment is to understand, the more an expert is needed.
It is important for investors to plan for various outcomes by holding a broad spread of assets, bonds, shares, cash, fixed-rate investments and property. These assets are often negatively correlated, giving a hedged performance. For instance, low interest rates have led to lower returns for savers and poor annuity rates have led to low pension returns. Therefore, having a mix composed of more defensive funds can protect a portfolio irrespective of the climate.
Chris Ferguson is a director of Credence International, a financial planning and wealth management company based in Dubai
Updated: February 27, 2015 04:00 AM