How to gain from stock market volatility

April 8, 2009
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, NAIROBI, Kenya, Apr 8 – It is now a little over one year since that Nairobi Stock Exchange (NSE) hit all-time highs and a little more than two months after dipping to five-year lows as the effects of the global economic meltdown began to bite.

What is astonishing to any keen observer is the negative publicity resulting from falls or drops in stock prices or indices. Rarely do we see some optimism from such declines. It is actually true to say that such drops should generate more excitement than pessimism from investors because of the opportunity that they present.

When the stock market is volatile, traders become jittery and and hold on to cash.This is a grave mistake because the value of cash is eroded by inflationary pressures. Ideally the returns from any investment should exceed the underlying rate of inflation.

With an inflation rate of about 29 percent, Kenyans are faced with very few investment options that would generate a return higher than this rate. This calls for wisdom when making any investment in the current economic situation.

Although it is understandable to be concerned about the falling value of your investments, it is possible to make volatility work for you. Investing regularly (monthly or quarterly) or phasing a lump sum investment can work to the benefit of an investor in a volatile market.

Depending on the currency the investment is made, this is called ‘cost averaging’ and this is how it works:

Assume that you invest a fixed amount monthly in a particular share in the stock market. If the value of the shares that you invest in falls, then your next monthly investment will benefit from the higher number of shares that you will be purchasing at the lower price.

Over a period of years cost averaging means that the average price paid can be lower than the average share price for that period since more shares are bought when share prices are low and fewer when the prices are high.
 
The same strategy can be used by investors with a preference for lump sum investments. That is, an investor can reduce the threat posed by volatility by splitting the sum into several monthly installments feeding it slowly into the market. This reduces the need to “time the market” and removes the risk of investing everything when the market is at its peak.

One of the best lessons that one can learn from investing in the stock exchange is the benefit of long-term investing. This means that an intelligent investor should not be swayed by short term volatility but concentrate on the long term objective which is portfolio growth.

Diversification is another strategy that can be used as an investment lesson.Never put all your “eggs in one basket”. Not all asset classes perform well at the same time and it is therefore good to have a diversified portfolio. This spreads the risk and increases your chances of making a sizeable return irrespective of the performance of the markets.

Financial advisers are trained to understand your financial goals, your time frame and comfort with volatility. Given the variety of investment options available and that each investor’s financial goals and circumstances are unique, we recommend you discuss your investment options with a qualified professional to find the solution that is right for you.

It pays to be informed as an investor but it is more important to ignore negative sentiment and focus on the long-term. The media may report investment news 24hours a day, seven days a week. What some investors fail tounderstand is that although the media may be informative, they often give a short-term outlook.

In conclusion, wisdom, patience, and adequte planning by an investor is the ticket to ultimate financial freedom.

(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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