Current Context:
Higher volatility in financial markets is being touted as the ‘new norm’. During choppy times in financial markets, investors are prone to making investment decisions based on emotions. Below are some tips on different ways to manage risk during periods of high volatility.

Move to a More Conservative Portfolio:

When markets are volatile, investors typically want to protect their investment portfolio from any further falls in the share markets. This is usually done by selling down some or all of their growth assets like shares and property and investing the proceeds in secure investments such as cash and/or term deposits. Unfortunately, investors tend to sell down risky assets after prices have already fallen. Nonetheless, this strategy is a good means of protecting your portfolio against further market downturns while providing some positive returns.

You may not necessarily need to take big steps by selling all or a significant amount of your growth assets. Instead, you can reduce your exposure to risky assets by making smaller tweaks. This way, you will have some protection on the downside while still maintaining some exposure to markets should the decision turn out to be wrong or inappropriate.

The timing of the sale of shares may also not be optimal from a tax perspective. There may be capital gains tax payable, particularly on shares that have been held for a long time. If the shares are held within your super fund, the maximum capital gains tax payable is 10%, so the tax implications may be less of an issue.

The biggest risk of this strategy is the risk of attempting to time the market and getting it wrong, thereby missing out on any recoveries in markets, which can often be very rapid and short-lived. Investing in a term deposit for, say, three years limits your flexibility to move back into the market if the opportunity arises before the maturity of the term deposit.

A lower exposure to growth assets can mean that your likelihood of achieving higher returns is reduced, which adversely affects the future value of your portfolio. You may be planning for retirement and base your plans on achieving a certain level of returns over time that, if not achieved, puts your planned future outcomes at risk.

Another risk to consider is longevity risk, as people are living longer. Adopting a conservative portfolio may exacerbate this risk because it limits the potential growth of your portfolio over time.

Switch to Defensive Investments:

You can switch to securities and managed funds that have a more defensive characteristic. This may be due to the share or managed fund providing exposure to companies that are more defensive either because their business tends to hold up better during economic downturns and/or it pays a higher level of income that cushions the total returns from a fall in its price. Certain assets like gold can perform well when there is greater uncertainty around the markets and are sometimes considered defensive investments.

You need to take account of the specific nature of the investments. If you are switching to a different type of investment, then it is important that you understand the risks and product-specific attributes of this investment approach. Another expected outcome of this strategy is that defensive assets may not perform as well as the overall market in the case of a market recovery. Any switching of investments may result in realized capital gains and transaction costs.

Maintain Your Portfolio’s Diversification:

Diversifying your portfolio by spreading the investments across a range of assets and investments is one of the fundamental rules for managing risks in a portfolio. Investing across a range of assets, including alternative assets and debt securities, can be an effective means of protecting your portfolio against market downturns. Avoid having a concentrated portfolio with limited exposure to a few assets or investments.

Consider Dollar Cost Averaging:

Making regular investments over time can allow you to avoid market peaks and troughs. This is done by buying more assets when prices are low and fewer assets when prices are high. The advantage of this approach is to lower the total average cost of the investment purchased over time. This strategy reduces the risk of making a large investment at the peak of the market.

Lower Gearing Levels:

Other strategies to consider include reducing the gearing levels if you have borrowed to invest. This may involve selling down investments to reduce the level of gearing and/or contributing additional personal funds to reduce the loan-to-valuation ratios. Lower levels of gearing reduce the probability of experiencing a margin call and the potential losses from a market downturn. On the flip side, it also reduces the gains from any market recovery.

Putting It All Together:

There are a range of levers that you can use to manage the impact of market volatility on your investment portfolio. Each has its advantages and disadvantages, and in some cases, a combination of strategies may prove to be a better outcome than simply relying on a single approach. Ensure you understand the implications and risks of the different approaches to make an informed decision.

The information contained in this article is general information only. It is not intended to be a recommendation, offer, advice or invitation to purchase, sell or otherwise deal in securities or other investments. Before making any decision in respect to a financial product, you should seek advice from an appropriately qualified professional. We believe that the information contained in this document is accurate. However, we are not specifically licensed to provide tax or legal advice and any information that may relate to you should be confirmed with your tax or legal adviser.