Financial Newsletter Sunshine Coast
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As it turns out and with the benefit of hindsight, since March 2009, the domestic and global market has rallied strongly.
The economic outlook is better than what it was a few months ago, both on the global front and domestically. The
domestic economy, whilst it has slowed sharply, has remained remarkably resilient when compared to other
industrialised economies. Many commentators have put this down in part to our links with the Chinese economy which
has also performed relatively well, the aggressive government fiscal stimulus packages and the Reserve Bank interest
rate cuts to the official cash rates. Interestingly, comments by the Reserve Bank suggest that further cuts to the official
cash rate may now be over, and that a rate hike is now not out of the question sometime in early 2010. So, it is fair to
say we are not out of the woods just yet.
Volatile markets are characterised by wide price fluctuations and heavy trading. They often result from an imbalance of trade orders in one direction (for example, all buys and no sells). The key message here is that volatility moves both up and down over the short term. Markets don’t simply move in one direction. In these volatile times, it is worthwhile reflecting on a few fundamental principles about managing risk and volatility.
Diversification has proven once again to be at the top of the list. By holding investments which are negatively correlated, that is, they move in opposite directions, the performance of the total portfolio will be less volatile. The best example of this is the performance of Australian equities and Australian bonds over the last financial year. Despite the significant underperformance of Australian equities last year, government bonds managed to post an impressive double digit positive return.
Second on the list is the inevitable trade-off with investing, that of risk and return. Investors that are too aggressive, face the potential risk of losing a large amount of their life savings that they may never recover in their investing lifetime. On the other hand, investors are too risk averse may not the build sufficient capital growth required at some stage to generate an income stream in their retirement. In essence, risk is an individual thing and more time should be spent on understanding the inevitable trade-offs.
Third on the list is the importance of taking a longer term view. The thing to realise is that market volatility is inevitable. It's the nature of the markets to move up and down over the short term. Trying to time the market over the short term is extremely difficult. For many investors this is a solid strategy, but even long-term investors should know about volatile markets and the steps that can help them weather this.
The last of the top four strategies to manage volatility is ‘dollar cost averaging’. This strategy aims to invest fixed amounts of money into the markets at regular intervals, regardless of market conditions. Given it is difficult to predict the future, averaging into the market reduces the risk of investing at the top of the cycle. Followed strictly, this strategy helps remove emotional decisions, making it easier to stick to a long term investment plan.
The Australian equity market has shown good signs of recovery, with the All Ordinaries Index retracing 33% from its low
in March 2009. But as always, diversification remains the key.
We would like to thank Aviva for contributing to this article.
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