The ups and downs of investing

Investors have been through considerable market turmoil over the last six months and more volatility can’t be ruled out. The outlook for the US economy is still quite unclear and investors are nervous about the prospect of it sliding into recession. If this happens, it’s likely to negatively impact other economies such as Europe and Asia, affecting corporate profits and lowering demand for goods and services.

Make a plan and work your plan

Having an investment plan is one of the best ways to help you ride out volatility in the sharemarket and reduce the risk of you making rash decisions. Less experienced investors can be tempted to dive in and out of investments in the hope of making abnormal gains or protecting themselves from large losses.

In contrast, seasoned investors know that market volatility is inevitable. The trick is having the right investment strategy in place to ensure you have the most appropriate balance between risk and return.

One of the keys to successful investing is having a plan. It should include what returns you want to achieve, when you want to achieve them, how you’re going to do it and how much risk you can tolerate.

Plus, you need to understand one of the most important investment rules which is the relationship between risk and return. It’s based on the principle that asset classes with the greatest risk (such as shares and listed property) produce greater returns over the long term. However, in the short term they are likely to experience the greatest volatility in their returns. Less risky assets, such as cash and fixed interest, are less volatile but also produce lower returns in the long term.

Strategies for volatile markets

1. Have a long-term view

When it comes to building wealth, it’s important to have a long-term perspective. This means that when the market is behaving erratically, you need to ignore any media hysteria and stick to your plan.

It may be tempting to jump out of the market to avoid further losses, but this can be an expensive and unnecessary strategy. While past performance is no guarantee of future performance, historically share markets have recovered after periods of volatility. Remember the old adage that ‘it’s time in the market rather than timing the market that counts’.

2. Diversify your portfolio

A powerful way to reduce the riskiness of your portfolio and smooth your overall returns is to diversify your investments. This means selecting asset classes and individual companies that are lowly correlated or their investment returns don’t move in line with each other. With regular rebalancing, a diversified portfolio can normally earn higher returns than the average returns generated from individual asset classes.

3. Use dollar cost averaging

Even the most experienced fund managers have difficulty picking the best time to buy and sell investments. It’s actually better to invest the same amount of money in the sharemarket at consistent intervals. This is called dollar cost averaging which helps smooth the fluctuations in entry prices. It also takes the emotion out of investing which is important during tumultuous market conditions.

4. Do your homework

While some stocks may look very cheap on paper, it’s important to go back to basics and examine their fundamentals. You need to select companies with solid management and strong cash flows. Avoid investing in companies when you don’t know anything about their level of gearing or debt covenants.

5. Talk to your financial adviser

During prolonged market volatility, it’s a good idea to re-examine your investment goals, time horizon, risk tolerance and financial circumstances. We will be able to determine the best strategy for you and make sure that you’re still on track to achieve your goals. Please call us if you would like to review your current situation.

Important information

The information in this article does not take into account your objectives, financial situation or needs. Therefore, before acting on the information, you should consider its appropriateness to your personal circumstances. Although this information was obtained from sources considered to be reliable, it is not guaranteed to be accurate or complete. This publication was prepared by AMP Financial Planning Pty Limited ABN 89 051208327. The information is current as at 4 March 2008 and may change over time.