SCC Chartered Accountants

Managing market volatility

The recent fluctuations in investment markets have highlighted the fact that there are risks involved with investing money - including your superannuation.

Firstly, it is important to understand that there is no such thing as a risk-free investment. Even so-called “risk-free” bank accounts suffer from the potential risk of your money losing purchasing power due to inflation.

As risk is always present the key issue is managing your exposure to risk and volatility to suit your particular investment profile.

Risk – what is it?

There are many types of risk which you face as an investor, including credit risk, currency risk, inflation risk, interest rate risk, liquidity risk, manager risk, market risk, security risk, systematic risk, and timing risk.

We are currently seeing the effect of some of these on investment markets due to uncertainty regarding inflation (both here and overseas), increasing interest rates (both here and overseas) and credit risk (ie: the current crisis in the sub-prime housing markets in the US).

These are some of the factors that are causing the current volatility in investment markets.

It is important to remember that investment markets move in cycles, and it is quite normal to experience high levels of volatility, such as we are seeing now, at some stage of the cycle.

How should you react to market volatility?

When it comes to making your investment strategy decisions (and choosing the appropriate mix between growth versus defensive investments) there are a number of important factors to consider.

The first are your financial objectives. How much growth in your investment do you need to achieve, to meet your goals? When it comes to superannuation savings your financial objectives refer to the sort of a lifestyle you want during your retirement years.

The second is your investment timeframe. How long have you got before you need to spend your invested money? For your super remember you may be invested well beyond retirement so your timeframe may well be 20+ years. Does this give you time to possibly benefit from some of the volatility in the market?

The third is your attitude to risk and return. Give some thought to the chart above and consider how well you would have coped with some of the negative periods if you knew you had 2 years, 10 years or 20 years left for your investment.

Once you have set a strategy you should review it regularly. You may only need to change your strategy a few times in your life.

Remember, as well, if you are in a relationship - your super especially may form a source of income for your partner - so it is important to consider your partner’s risk profile. Too often couples don’t discuss their attitude to investing until they approach retirement so plan the strategy together.

Finally, as investing can be an emotional experience, speaking to a licensed professional will help.