How to wade market volatility

January 27, 2009
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, NAIROBI, Kenya, Jan 28 – Not even Barack Obama’s inauguration on January 20 could take the world’s eyes off the global economic crisis. And as billions watched one of the momentous political events in history, most were more interested the steps his administration would take to resuscitate a faltering economy and revive investor confidence that has fallen to a near zero.

Financial markets are more vulnerable to sudden withdrawals of liquidity or loss of confidence. Unlike money in a bank or building society deposit accounts, the value of stock market investments can go down or up. This volatility causes understandable concerns to investors.

With the current market volatility, many investors are rethinking their investment strategies while others are even questioning the rationale of investing in the stock market. The truth however is that investors are better off resisting the temptation of making changes to their long-term investments simply because of short-term market volatility.   

Investors need to understand that stock markets are prone to short-term fluctuations and sometimes these can be quite sharp. It can therefore be tempting for investors, particularly those with short-term interests, to delay making new investments or even consider selling existing investments and try investing again when values are lower – this strategy is called “Market Timing”. Although market timing may sound great in theory, it rarely works in practice. Investors who believe in market timing always miss the best gains. Investors need to remember that time and not timing is the key to great investing.

What has been most deceiving to many investors is that the stock market is a “get rich quick” investment option. No one has become rich solely by investing in the stock market, but rather by making the right stock investment decisions.

Warren Buffet an American investor, businessman, and philanthropist admits that the United States economy and the world’s in general are in shambles. However, despite the rising unemployment, faltering business activity and pessimistic headlines, he believes that this is the best time to buy stocks.

“I can’t predict the short-term movements of the stock market. I haven’t had the faintest idea as to whether stocks will be higher or lower a month or a year from now. What is likely however is that the market will move substantially higher. A simple rule dictates my buying. Be fearful when others are greedy, and be greedy when others are fearful.”  

When investing in the stock market, investors need to have an ultimate goal. Some people have invested in stocks in preparation for retirement while others do it as a form of investment diversification.

The concept of risk and return is very important. Too many people really don’t grasp the level of risk they take with their investments. As a general rule, investors should always aim to buy low and sell high. This is something that a majority of private investors regularly forget and as such do the exact opposite. It is such mistakes that leave stock market investors in despair over investing in stocks.

We have so often focused on the “what to do when investing in stocks,” and mentioned little of the greatest mistakes of stock market investing.  One of the most common mistakes when investing in stocks is reliance on past performance; some investors base their current decisions on what happened in the recent past. Just because a stock gained 10 or 15 percent in the last one year does not mean it will do the same this year or the year ahead.

Do not buy investments that do not match your risk profile. Some investors are naturally cautious and yet their investment portfolios predominantly consist of stocks whose performances are highly volatile.

Few believe in diversification despite it being one of the best lessons any investor could learn. Not all asset classes or stocks do well at the same time and spreading the risk would be advisable.

Many investors have fallen victim to overpaying for their investments. Just like buying a car or a house, do your research before buying into an investment. Most investors have paid for stocks twice the amount they should have paid for them. With the normalisation of prices, the same investors have seen the stocks lose their values dramatically. 

It pays to be a stock market investor. It is the best way to build wealth for the long term. However note that …” it is easy to forget that a share of stock is not a lottery ticket, its part of ownership of a business.” Peter Lynch – Wall Street stock investor.

(Renaldo D’souza is the Marketing and PR Coordinator at Winton Investment Services Ltd, an Offshore Investment Advisory Company based in Nairobi)

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