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Article written by Kellands Hale, our preferred independent advice firm.
This article is not intended to be financial advice to any individual. The views expressed are those of the author and Moneyfacts.co.uk does not endorse the content.
Here we take a closer look at volatility, the importance of time and the power of diversification.
When making an investment, time matters. Usually, it takes time for an investment to come to fruition. For example, if you buy shares in a company on the basis that it looks well placed to prosper in the future, then it’s logical that it’ll take time for that potential to be realised.
In the short term, however, your investment can be prone to volatility.
In simple terms, volatility is a measure of the size of short-term changes in the value of an investment. It is a feature of virtually any investment type, meaning the journey towards your long-term financial objectives is likely to contain ups and downs along the way.
There are no guarantees of course, and volatility may mean that you may not get back the original amount invested when you decide to withdraw your investment.
Looking at the performance of UK shares in a calendar year, 25 of the past 36 years have seen positive returns. Interestingly though, 26 of the past 36 years witnessed large falls in the market during some part of the year.
Despite these years in which shares have faced severe volatility, the message is clear. Had you invested in UK shares over an extended period, the chances are that years of positive returns will outweigh periods of disappointment.
Volatility is a clear feature of investment in UK equities, but time and again it has paid dividends to put short-term fluctuations in context and focus on the timescale that really matters – the longer-term one.
Is it possible to time the market? In the absence of a crystal ball it seems an unlikely ambition, particularly when you consider some of the unpredictable factors that can affect markets.
How many predicted the global financial crisis in 2008 or the tech bubble bursting earlier in that decade? More recently we’ve seen markets swing sharply in the short-term due to the impact of the COVID-19 global pandemic.
Trying to beat the market by taking short-term positions to avoid losses is unlikely to be a successful strategy and the flip side is the cost of potentially missing out on the days when markets do rise strongly.
Volatility is part and parcel of investment and given enough time its effect can prove to be relatively limited. Still, significant downward fluctuations in value would obviously be unwelcome.
Therefore, it can make sense to consider diversification to limit the impact and extent of short-term moves.
Diversification is a proven principle for generating returns in a more consistent and reliable manner. It’s a simple concept: asset classes (like equities, bonds and property) have different characteristics. So, by spreading your investments across a number of them it’s possible to participate in a broad range of opportunities while smoothing out extremes in terms of positive and negative performance.
Diversification can result in a smoother journey towards the investment outcome you’re trying to achieve. According to our data, a portfolio invested in equal amounts of the different asset classes would have produced an average annual return of 8.06%.
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