Learn about market volatility

What is volatility?

Volatility is a measure of how much the value of an investment changes over time. It is an inevitable part of investing as asset prices and markets move up and down in response to various factors, however, the level of volatility will vary across different asset types.

Low volatility asset prices are usually steadier over time, while high volatility asset prices fluctuate more dramatically. Stock markets are generally more volatile than bond markets, and within those markets different types of securities are likely to experience different degrees of volatility.

What causes volatility?

Volatility can be triggered by all kinds of things but is generally related to either a change in investor perceptions (positively or negatively) of the prospects for an investment - for example, a company takeover - or uncertainty around the market impact of events such as political developments, natural disasters or a change in economic indicators.

How should investors approach volatility?

Volatility is often considered to be the same as risk. It is a type of risk but it is important to remember that volatility is normal and can even be helpful to long-term investors who can stay invested through shorter-term fluctuations to potentially benefit from stronger returns generated by buying assets at temporarily cheaper prices.

What matters is the time horizon of an investment. The difference between an asset’s price at the opening and closing of an investment is much more important than how much it fluctuates on the journey between those two points. However, selling an asset at a point in time when the price has fallen means locking-in a loss. Some investors do not have the time horizon or willingness to tolerate high volatility.

It is important to build portfolios that have the ability to ride out market volatility. Lower volatility assets will smooth the ‘journey’ but higher volatility assets often come with higher rewards. Various types of assets also respond differently to different market environments. This is why diversifying portfolios across low and high volatility assets is key to navigating markets through the cycle. The balance of assets in the portfolio can be actively managed to shift allocations as markets move and change.

Fixed income investing is generally considered the main component of the low volatility portion of the portfolio. However, assets which have traditionally been considered ‘safe’ such as mainstream government bonds no longer pay an adequate level of income to meet most people’s goals. Fortunately, fixed income is a broad spectrum of risk and return profiles with a wide range of opportunities to choose from, depending on the desired outcome.

A range of options to help investors reach their financial goals

 

 

Invest for a conservative profile

 

Invest for capital growth

 

 

    

 

 

In an uncertain and low interest rate/low yield environment, cautious investors looking to put cash to work might consider bonds that have a shorter life span, known as ‘short duration bonds’. While not risk-free, the potential reward is a more attractive return than cash while minimising exposure to risk and the impact of market volatility.

 

 

Investors who are willing to take on more risk can reach further to aim for higher rewards. High yield bonds offer the potential for enhanced income and equity-like long-term return potential, generally with lower volatility. They can also provide good diversification for other fixed income assets.  Investors can aim to manage the risks through diversification, careful security selection and ongoing monitoring.