Major market events, such as the global financial crisis, which caused massive market changes and volatility, prompted many investors in global markets to reconsider how they deal with market volatility, understand it more accurately, and take it seriously.
When stock markets are under severe pressure for various reasons, anxious investors resort to selling their shares to avoid losses if the markets continue to decline. However, selling at a low price means a loss if the stocks recover again.
Strategies for dealing with stock investment risks
Here are 6 strategies for dealing with stock market volatility and reducing investment risks during periods of turmoil:
1. Shift from growth to value
During periods of economic turmoil, investors typically shift from holding stocks of growth-chasing companies that are more risky (such as non-profitable technology companies) to well-known, older, reliable companies that pay dividends (such as insurance companies and banks, which are known as defensive options in the stock market).
Another safe haven is value stocks, companies that investors dislike and whose share prices do not fully reflect the value of their assets. They have become a defensive strategy for many fund managers.
2. Search for large size
Small companies are more vulnerable than others, and their shares often sell off faster during times of crisis than their larger, more established peers, so anxious investors may consider avoiding them during turmoil.
Tom Stevenson, investment director at Fidelity Personal Investing, says that shifting to larger companies reduces risk, but there may be exceptions to this rule.
3. Focus on dividends
In weak economic conditions, companies that pay good dividends become more attractive than those that cannot match them, and in some markets there are investors who focus only on this type of stock.
In the UK, income funds, which aim to provide annual returns to investors, focus on this sector of companies regardless of economic conditions or defensive situations.
4. Diversification
Investors are often told to apply the famous maxim “don’t put all your eggs in one basket,” however some reliable funds may concentrate their investments in specific sectors or regions.
For example, the British fund “Fundsmith Equity” invests 65% of its funds in the United States, while the Scottish fund “Scottish Mortgage” invests 28% of its assets in the technology sector.
This strategy can generate strong gains if investment managers choose stocks well, but the opposite is true. If their choices are not successful, the losses can be huge.
5. Looking beyond stocks
Some funds look beyond stocks to achieve strong returns, a strategy that actually helps them at times, and this may include some derivatives.
Passive investment funds that closely track stock indexes can lose as much as they can gain.
Some UK funds plan to pay 7% of the annual income they give to their clients through stocks and derivatives, believing that this way they may secure more profit if the markets become unstable.
6. Comparing active and passive investing
Unlike active asset managers, where one can pick or avoid stocks to mitigate the effects of downturns, these computer- and algorithmically managed funds do not have the luxury of choice, and during market volatility their path is only downward.
In passive investment funds, there is nowhere to hide, experts say, and a few large companies can dominate the performance of a particular index, ultimately making the investment not as diversified as it seems.Tags
