3 Ways To Beat Volatile Markets

Published in Investing on 20 October 2011

Simple steps can smooth your returns.

As recently as early July, the FTSE 100 stood comfortably above 6,000. Happy days were here, we thought.

But by early August, London's premier index was flirting with 5,000 -- and on several occasions dipped below that level in intra-day trading, most recently as early October. On 4 October, it closed at 4,944.

All of which goes to show that we shouldn't take today's level of 5,400 or so for granted. From here, the index could go anywhere -- and with it, pension savings, incomes, and the built-up wealth of countless investors.

Worrying times

In short, volatile conditions look likely to be a feature of the investing climate over the short-to-medium term.

Whatever our politicians might hope for, the eurozone's problems, high national debts, and tepid economic recovery aren't going to go away any time soon.

So what's an investor to do? Sadly, history already tells us what many investors are doing: cutting and running, deciding that the stock market isn't for them, and taking their losses on the chin.

Fortunately, there are better options.

Diversification

First, spread your wealth -- and your risks. A portfolio spread across asset classes will always be more resilient to adversity than a portfolio concentrated on just one asset class.

That's why investors are urged to spread their portfolios between shares, bonds and gilts, and cash. When the stock market is racing away, gilts and cash may not seem exciting. But when it's plunging, they offer steady returns and reassurance.

Take a look at a table produced by fund management firm Fidelity, showing the returns that asset classes enjoyed during various economic conditions over the period 1973-2010. Each class enjoyed booms, to be sure -- but also busts.

EconomyBondsStocksCommoditiesCash
Reflation10.6%-0.1%-25.3%3.4%
Recovery6.7%20.7%-8.2%2.1%
Overheating0.0%8.1%18.9%0.8%
Stagflation-1.1%-14.9%29.6%-0.8%
Average return3.4%5.2%4.0%1.3%

Source: Fidelity

Effective diversification improves portfolio efficiency, says Fidelity, by helping to ensure that for any given level of risk, investors maximise their returns.

What's more, it adds, multi-asset funds have the potential to boost returns further through tactical asset allocation -- where weightings are tweaked according to prevailing economic conditions.

And you don't have to put your money in a fund to achieve that, although many investors do, of course.

A judiciously-acquired mix of shares, bond-and-gilt ETFs and cash would do much the same trick, too -- and arguably at lower cost.

Hold for the long term

Here at The Motley Fool, we're generally buy-and-hold investors.

That's because investment churn saps performance through trading costs. It's generally better, goes the logic, to take your time over the selection of a stock, pick decent businesses run by skilled managers, and let them get on with the job of building your wealth.

It's certainly a strategy that has worked well for Warren Buffett, of course. "When we own portions of outstanding businesses with outstanding managements, our favourite holding period is forever," he told investors in his 1988 letter to shareholders.

Fast approaching sixty, I'm old enough to remember all sorts of stock market crashes and periods of under-performance -- the causes and durations of which are long since lost in the mists of time.

What I do know is that markets eventually recover, and carry on heading upwards -- carrying our stocks, and investment wealth, with them.

High-yield equities

Always a popular pick, high-yielding FTSE 100 behemoths have the size to resist adversity, while continuing to throw off cash year after year.

Quite simply, defensive consumer-centric stocks such as Diageo (LSE: DGE), British American Tobacco (LSE: BATS), Tesco (LSE: TSCO), and Unilever (LSE: ULVR) have been weathering adversity for years, rewarding shareholders with dividends all that time.

And those dividends play a useful role in countering market volatility, argues Fidelity's Dominic Rossi. For while many investors are still deeply rooted in the concept of investing for straightforward capital growth in equities, the investment landscape has changed, he reckons.

In a lower growth and interest rate environment for developed economies, he points out, it now makes sense to look at equities from a total return perspective: capital growth and accumulated income over time, too.

In short, remember the importance of compounding and dividend reinvestment: over time, compounding even seemingly paltry dividend payments can contribute significantly to total returns.

Bottom line

And the good news is that while markets today are just as volatile and unpredictable as they've been at similar points in the past, investors today have a huge advantage over their predecessors.

Simply put, in times past the cost of taking some of these preventative measures was simply prohibitive. Funds were expensive; brokers' dealing costs astronomical, and low-cost ETFs and index funds didn't exist. Nor did low-cost ISAs and SIPPs.

Today, the world of investment has been transformed. Markets may fluctuate erratically -- but that doesn't mean that your portfolio, and the investment returns from it, must also follow suit.

More on the markets:

> Malcolm owns shares in Tesco. The Motley Fool owns shares in Tesco and Unilever.

> Worried about the state of the stock market right now? Then get The Motley Fool's free guide on What To Do When The Market Crashes

Share & subscribe

Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

BarrenFluffit 20 Oct 2011 , 6:19pm

"high-yielding FTSE 100 behemoths have the size to resist adversity," Ok it takes a sudden event to have them go bust without dropping out of the footsie but its happened; British and Commonwealth Holdings springs to mind.

MDW1954 20 Oct 2011 , 10:43pm

BarrenFluffit,

You make my point for me: I rest my case.

Malcolm (author)

piecan 23 Oct 2011 , 12:20pm

I agree entirely; relying on one asset class is very bad news. I know the HYPers, and others, will disagree because about 80% of the posts are in favour of FTSE defensives but common sense tells us differently.
While the Fidelity asset allocation has merit and is far safer than any one asset class in isolation, I feel that Harry Browne's Permanent Portfolio is far superior and that is the one I put my money on - literally.

popsranola 24 Oct 2011 , 1:53pm

You are it is defensive stocks........It is Boring but safe......

ANuvver 24 Oct 2011 , 7:18pm

Len83: I agree on asset class diversification, but with a caveat about timing.

The HB Permanent model is fine, but I don't think now is the time to be ruthlessly repositioning (or positioning ab initio) for the perfect fourway split.

LTBHers know that it takes quite some time to accumulate a portfolio, since not everything will be "on sale" at once. Of course there are rare times, as now, when equity bargains are easier to find across the board.

It takes just as much time to build asset class diversification.

I believe that at the moment big sovereign debt is horribly overpriced aro safe-haven buying (though what's quite so "safe" about guaranteed inflation erosion puzzles me). So I think it makes sense to be long safer income equities. As and when risk is back on with a degree of conviction, gilts will sell off. Then will be a good time to topslice your equity holdings to raise your bond exposure - prices will drop; yields will rise; you'll have more to play with.

While waiting for this happy alignment, there are still modest prospects in corporate fixed-income, which will help to smooth overall volatilty.

The same logic pertains with gold. I'm still trying to educate my inner Midas, but can't shake the feeling that the spot price has further to drop before it continues upwards.

Anyone who is pigheadedly HYP, GARP, WIBBLE or whatever, to the exclusion of all else is going to come a cropper sooner or later. I suppose the Harry Brown model is attractive in that it's a chariot with four equally strong horses. But don't forget that you can trade horses given what's best value at the time, until you finally arrive at the best team.



MDW1954 24 Oct 2011 , 8:43pm

Thank you all for your comments.

ANuvver: agreed.

Malcolm (author)

ANuvver 25 Oct 2011 , 2:17am

Cheers Malcolm.

PS Careful all...

IMHO, we're about to get a serious "buy rumour, sell news" hit after Wednesday, particularly in financials. Recent action has the nasty smell of "pump and dump" about it...

Join the conversation

Please take note - some tags have changed.

Line breaks are converted automatically.

You may use the following tags in your post: [b]bolded text[/b], [i]italicised text[/i]. All other tags will be removed from your post.

If you want to add a link, please ensure you type it as http://www.fool.co.uk as opposed to www.fool.co.uk.

Hello stranger

To add your own comment, please login.

Not yet registered? Register now.