The Motley Fool

Learn to love volatility: A private investor’s cheat sheet

In my view, private investors could welcome events like the EU referendum and any share price volatility they bring if they just remember a few simple points.

Embrace your freedom

Fund managers may have access to vast amounts of research and highly informed analysts but they’re also constrained by investment objectives. If a share gets too big, small, volatile or cuts its dividend, it may be jettisoned. Index trackers suffer from the same problem. Private investors are at an advantage because they have the freedom to buy pretty much whatever they want, whenever they want and even go where others fear to tread. This doesn’t guarantee success but it doesn’t prevent it either.

Focus on company prospects

Just because a leading index is tumbling doesn’t mean the prospects for a company you’ve invested in have changed for the worse. A vote to leave the EU could see the FTSE 100 drop significantly on account of financials and housebuilders making up a significant percentage of its constituents. But many decent, resilient companies might also be dragged down for no reason. If the investment case hasn’t changed, ignore the bigger picture and stay the course.

Have a war chest

It’s essential that investors are able to take advantage of shares going cheap. As such, I recommend always having a portion of your portfolio in cash, ready to be employed when an opportunity presents itself. There are few things more frustrating in investing than being unable to do so.

Write a watchlist

There’s no point being in cash if you haven’t identified shares you’d be keen to buy if their prices dipped. Otherwise, you run the risk of impulsively jumping into investments without conducting the necessary research/due diligence. If, as the philosopher, Sun Tzu postulated, “every battle is won or lost before it is fought,” having at least an idea of likely destinations for your capital should markets go into panic mode is beneficial. My own watchlist is dominated by expensive, high quality companies that I would only purchase if prices dropped significantly.

Focus on the long term

Private investors have time for their shares to grow or recover. Fund managers are judged on their performance over a relatively short period of time, hence the herd mentality and index-hugging antics (in which funds mirror the main indexes and refrain from trying to outperform the latter as they’re paid to do). As long as you believe in the companies you own and don’t need immediate access to your capital (if the latter, I’d argue that you shouldn’t be investing in the first place), panic-selling can be avoided.

Be diversified

Investing in a group of companies in just one sector is strongly discouraged. Although all share prices tend to be affected during market panics, some (such as utilities and pharmaceuticals) cope better than others. Buying shares in a group of UK housebuilders before the EU referendum, for example, is a risky strategy. Investing in one (alongside other, less cyclical, multinational stocks) isn’t because your other shares should compensate for the housebuilder in the event of a Brexit.

Drip-feed capital

Ultimately, nobody knows where share prices will go next. As such, it can sometimes be best to drip-feed your capital into new or existing investments and benefit from pound-to-cost averaging (where more shares are purchased at lower prices and fewer at higher prices) rather than invest a lump sum in one go.

Any other advice?

Of course, the ultimate way for most investors to handle volatility is to pay absolutely no attention to it. If market jitters become too much, simply stop monitoring your portfolio for a while. And if you've followed the points above, you can safely ignore the doomsayers anyway.

That said, it's understandable if recent talk of market volatility may be causing some anxiety, particularly if you're only just finding your feet in the stock market. Sometimes, telling people not to panic makes them panic even more. And then they panic about panicking. And then they sell good shares when they should be buying them.

That's why I strongly encourage you to read a FREE report produced by the experts at the Motley Fool. Entitled The Worst Mistakes Investors Make, this brand new guide contains a number of handy tips to help you through tricky moments on your investing journey.

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