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Market Watch – Volatility
The volatility of markets around the world naturally leaves investors concerned about the security of their investments. While this is understandable, it is also critical to understand why markets are volatile, how to manage the impact of volatility in the market, and the implications of cashing out your investments.
Why are markets volatile?
Many things can affect global markets – industry, politics, economics and social factors to name a few. Between governments making poor financial decisions and a natural disaster shutting down large parts of an economy, market volatility is inherently unpredictable. Not only that, markets are also cyclical in nature, and research shows that asset classes that experience short-term negative growth can still provide longer term positive growth.
Managing the impact of market volatility
One of the most effective ways to handle market volatility is to diversify your investment portfolio. This can help deliver smoother, more consistent results over time. Investments may benefit from being spread across a broad variety of asset classes including shares, cash, direct and listed property and fixed income. Market falls in one of these classes can be softened by the likelihood that your other investments are still performing well.
Understanding your risk profile is also important when investing, especially since ALL investment carries risk. The amount of risk you take in through your investment activities will be influenced by a range of factors, including personal risk aversion, family considerations and financial goals. Market volatility can cause investors to worry and even perhaps reassess how they feel about risk. If this is the case, talk to your financial adviser to consider any changes to your financial plan.
The implications of cashing out
Withdrawing from investments due to short term volatility can carry significant risk. Three main risks you could encounter are:
- Crystallising losses.
- If the value of your investment is falling, you are (technically speaking) only making a loss on paper, and sticking with it may prove beneficial if the stock turns around and returns you to profit. Selling an investment turns the loss into a very real one, and also makes it irreversible.
- Losing the benefits of compounding.
- Even taking out part of an investment can be unfavourable in the long run. The withdrawal itself is a loss, along with any future interest and earnings on that amount.
- Capital Gains Tax (CGT).
- Before you sell any asset, make sure you fully understand your potential CGT liabilities. This can potentially reduce your overall investment benefit to the point where selling is not worth it.
Whilst shorter term volatility can cause stress and angst amongst investors, it is important to recognise the longer term nature of investing and that shorter term price fluctuations should not be the main driver that affects your decision-making processes. If you are concerned about volatility affecting your portfolio then talking to a financial adviser and undertaking an investment review and plans can provide peace of mind that your investments are on track to achieve your goals. Contact McKinley Plowman today on 9301 2200 or visit www.mckinleyplowman.com.au.
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