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Investing in financial markets can become particularly stressful during periods of high volatility. When markets fluctuate sharply and the value of investments drops, many investors feel anxious and uncertain about what to do next. However, it is imperative to understand that volatility is a normal and unavoidable part of the investing process. As Kavan Choksi points out, markets naturally move through cycles of growth, decline, and recovery. Rather than fearing these fluctuations, investors should try to learn how to manage them effectively.
Kavan Choksi Provides A Few Strategies for Managing Risk and Market Volatility
Market volatility often leads to emotional decision-making. When there is a significant decline in prices, many investors panic and sell their investments in an attempt to avoid further losses. While this reaction may provide short-term relief, it can create long-term problems. Many investors who sell during difficult periods hesitate to invest again until the market appears stable, which is why they miss the early stages of recovery.
Historical market performance demonstrates that missing even a few of the best-performing days can significantly reduce long-term returns. Because strong gains often occur shortly after periods of decline, investors who exit the market may lose the opportunity to benefit from these important recovery periods. Hence, it is crucial to maintain a thoughtful and strategic investment approach rather than reacting impulsively to temporary market drops.
Here are a few strategies one may follow to manage risk and market volatility:
- Create a mix of asset classes with low correlation: One should consider spreading investments across assets that do not always move in the same direction. When assets have low correlation, the performance of one investment may help balance the losses of another.
- Diversify equity portfolio: Instead of concentrating investments in a small group of companies or industries, investors should try to spread their money across varied types of stocks. This may include a mix of domestic and international companies, as well as businesses of different sizes like small-cap, mid-cap, and large-cap firms. One may also invest in companies belonging to varied sectors to create a more balanced portfolio. As different industries are likely to perform differently under changing economic conditions, this approach can reduce the impact of downturns in any single sector.
- Consider dividend-paying stocks: Dividends are regular payments made by companies to their shareholders, usually from profits. These payments can provide investors with a consistent stream of income even when stock prices fluctuate. Companies that pay dividends are often well-established businesses with stable earnings and strong financial positions. Many companies maintain their dividend payments even during challenging economic periods. As a result, dividend-paying stocks can provide a level of stability within a portfolio.
In the opinion of Kavan Choksi, while sticking strictly to the long-term plan might be the best decision, at times, investors may also make temporary adjustments to their asset allocation during uncertain market conditions. For instance, if an investor believes that a prolonged downturn may occur, they might increase the portion of their portfolio held in cash or cash-like investments for a limited period. Holding more cash can reduce exposure to market losses during a decline.