Is volatility always a bad thing

There are always things happening to unnerve markets and cause volatility, from changes in commerce, to politics, to economic outcomes and corporate actions. Volatility is an investment term for when a market or security experiences swings in either direction, up or down, that deviate from the norm. If the price stays relatively stable, the security has low volatility. A highly volatile security hits new highs and lows quickly, moves erratically, and has rapid increases and dramatic falls. However, volatility often gets a bad rap because people tend to focus on falls more than they do the gains.

You may have heard the term, “Low risk, low reward”, well the same applies to volatility- low volatility of an investment typically means lower potential returns. That is why cash in a bank account with minimal volatility compared to other investment types carries the smallest level of returns. Shares, on the other hand, come with much higher volatility than cash, but investors would expect higher returns. So, if you want low volatility, be prepared to accept lower returns.

Seasoned investors know that price fluctuations, and the risks that come with them, are the cornerstone of how markets work. It might be unsettling, but it’s all ‘normal’. No matter how normal it is; when markets fall it can be scary. Many will panic and decide to sell their holdings before things drop further, thus exacerbating the crash. While it is an understandable instinct, the price you pay for selling amid volatile markets also locks in your losses.

For those who sold amid last year’s volatility, that lesson hit particularly hard since markets quickly rebounded from the March lows, driving home the pain of cementing their losses. Those who remained steadfast in the face of adversity were able to ride out the lows and saw their portfolios recover for the most part.

Some not only resisted the urge to sell, but they also saw an opportunity to buy. That’s where volatility can get interesting because if you understand volatility and its causes, you may be able to use it to your advantage. An example is when you can buy bonds or stocks of good companies, whose fundamentals remain strong but whose prices are nevertheless falling.

However, if this strategy is going to work, ensuring that the bonds and stocks you buy retain their quality is key. It is vital that you are buying for the right reasons, and not just because something looks cheap. This can be achieved by doing credit research to make sure companies are robust and have the liquidity to survive. Ask yourself (or your advisor) questions like: “If these companies had no revenues for more than 12 months, would they be, ok? Do they have other business revenue streams? Do they have asset backing, for example do they own valuable real estate that can be liquidated to meet financial obligations if needed?”

Volatility is inevitable in a healthy market, and every long-term investor will experience it from time to time. When investors have a mindset that accepts volatility as an integral part of investing, they are less likely to be surprised when it happens, and more likely to react rationally, focusing on their long-term investment goals. They will also realize that volatility is not always a bad thing as market corrections can sometimes provide investment opportunities.

Toni-Ann Neita-Elliott, CFP is the Vice President, Sales & Marketing at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual, and institutional investor. Visit our website at www.sterling.com.jm   

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