DAILY FINANCIAL TIPS – DAY 46 – HOW TO REDUCE INVESTMENT VOLATILITY
Many people open their investment statements with trepidation – wondering if their investments have increased or decreased. Investment values fluctuate regularly due to market conditions. That is very normal and to be expected. Large or significant fluctuations in value however can be very disconcerning. Our comfort level with the magnitude of investment fluctuations will depend on a number of factors and is never the same for any two investors. How soon do you need your money? What is the money being used for? What is your investment style? What is your family situation? What other resources do you have? All factor in to our comfort with investment fluctuations.
Regardless of your situation, there are a few strategies that can be used to minimize or smooth out investment and market fluctuations. Firstly: what is the asset mix of your investments. Different asset classes (ie cash, bonds, stocks) react differently in different market conditions. Having a mix of these asset classes and the proportional mix of these asset classes will reduce your investment fluctuations.
Cash/GIC is the least volatile. There really is no market fluctuation. You are investing your money for a fixed period of time in exchange for a fixed interest rate. While there may not be market risk with GIC investments and cash holdings, there are other risks such as inflation risk (the value of your money will diminish over time due to inflation) and interest income is taxable.
While Bonds have lower market volatility, they will vary in value depending on interest rate conditions – increases and decreases in interest rates will decrease and increase bond values. The duration (length of time until the bonds mature) will influence the degree or volatility in bonds and bond portfolio values.
Stocks have the greatest degree of volatility, however, different types of stocks fluctuate differently in different market conditions. Having a diversified portfolio of stocks will help reduce stock volatility.
Making regular contributions to your investments (ie monthly) or the concept of dollar cost averaging (see day 38 Daily Financial Tip blog post) will reduce investment and market volatility by reducing the average cost over time.
Taking a long term investment perspective will help offset market volatility. Remembering the investment adage of ‘buy low and sell high’ is easier when taking a longer term view of your investments. If you require your monies sooner for a purchase (ie home, child education, etc), then taking a more conservative or cautionary investment strategy for these investments is prudent. Taking a longer term view will ensure you don’t make potentially costly short term investment decisions which may have longer term detrimental effects on your portfolio.
It is best to engage the services of a Financial planner or investment advisor who can help put your investment decisions into perspective with and outside and professional view. Studies show that people who engage an outside advisor with their investment decisions accumulate 20% – 30% more wealth over the long term. Always put your investment decisions into the perspective of your own individual family and personal situation.
These daily financial tips are designed to be short ideas covering different aspects of family and business finances. They are short pieces intended to provide information to enable individuals, families and businesses to make informed financial decisions. Not all tips will apply to every situation, but over the course of a year, most financial topics will be covered. Check in regularly and share with friends and associates.