14 February 2022

Understanding market volatility: how to prepare for a potential market event

Everyday Kiwis have jumped into share investing with gusto, empowered by easy-to-use online investing platforms, a buoyant market, spare time and cash as a result of pandemic lockdowns. 

But many newer investors have never experienced a market event where share prices drop significantly and then stay lower for a while.  Share markets dipped in March 2020 when Covid-19 first hit, but recovered quickly. 

Share markets rise and fall, which is a normal part of investing.  The next market event could happen at any time, and it might take a few years for markets to recover from a downturn.  History shows us that markets can and do come back – but it might take time.   

If you do not need that money for some time – say 3-5 years – the best approach is likely to do nothing and wait for markets to recover. 

There are a few things you can do to make sure you and your investments are best positioned to weather any potential ups and downs.  

The importance of an emergency fund 

Having ready access to money you’ve set aside in an on-call cash account will mean you're not caught short financially when unexpected events occur.  

During a market downturn you don’t want to be in the position of having to sell your investments at a loss, just because that’s when you need the money.    

Find out more about having a good money foundation on the Sorted website

Be deliberate  

The first step in managing your response during a market downturn is to have a plan.  You are more likely to respond in your better interest during a market event if you know what you are investing for.  View the Sorted website for planning tools.

Have a think about when you plan to spend the money.  If it’s not for 10 years or more, you probably have time to ride out any potential volatility.  But if it’s soon, you may want to consider a lower-risk investment.   

Know how much risk you can take.  If you know you’re the type of person who could lose sleep if your investment balance halved, perhaps consider a lower-risk investment which is less likely to be affected by volatility.  Your returns will likely be lower, but it may be worth it to you to avoid the potential stress. 

A note on risk, time, and market volatility  

When choosing an investment product typically higher risk investments are more volatile. They may offer higher returns, but they are also more likely to take a greater hit if the market drops. 

Make an informed decision. It can be tempting to invest in the latest trendy company or follow what others are doing on social media, but it’s important to do your own research.  And stick to the plan! 

Read more about how to choose an investment

Read more about getting financial advice

Diversify  

One of the best ways to protect yourself against volatility is to diversify your investments.   

It might sound complicated, but it’s just a fancy way of describing having a mix of different types of investments.  For example, you could invest in a variety of different companies, industries and countries, and include some other asset classes in your portfolio like bonds and cash.  

This protects you from a single investment going wrong and causing you to lose a significant percentage (or even all!) of your money.  

Some investments come pre-diversified, like KiwiSaver and many managed funds.

Read more about diversifying

Find out more about Managed Funds

Drip-feed   

Another way you can manage market volatility is by drip-feeding your investment.  This means regularly investing the same amount of money - for example $20 each pay period.  By buying regularly, (also known as dollar-cost averaging) you buy regardless of when prices or high or low, smoothing out fluctuations.  

If markets drop it can be tempting to stop contributing.  But many investors see a market dip as an opportunity to buy shares more cheaply, helping to grow the value of their investment when markets recover.  By continuing to drip-feed regularly and with a long-term horizon, you can take advantage of low prices.   

If you have a big amount to invest, some experts recommend investing it in chunks over time rather than investing the whole amount all in one day. 

Read more about drip feeding your investments

Read more about getting financial advice

Don’t freak out  

Finally, if there is a market event, remember that it’s time in the market that matters.  History has shown that investments in the share market have grown more over the long term (10 years or more) than almost any other type of investment.  Even severe market crashes associated with the GFC in 2007 or the Wall Street crash of 1929 were followed by periods of significant recovery in share prices. 

Seeing your balance drop can be unsettling, though, so you may want to consider not looking or only checking it every few weeks.  Don’t “doomscroll”!  Don’t pile on extra stress by checking your portfolio every day, even when it’s super tempting.  You are investing for the future; this is a long game. 

FMA research into investor behaviour during market volatility in March 2020 found that regularly seeing your investment balance could encourage you to think of it like a savings account – which it isn’t.     

So if there’s a market decline remember you haven’t lost any money, the value of what you’ve invested in has temporarily declined. But if you choose to sell your investment now, that’s when money is lost.  

Read more about how to deal with a market fall

Read more about recognising the signs of a scam

FMA research on KiwiSaver fund switching behaviour March 2020  

When the market crashes, some people sell their shares or move their savings to lower-risk investments.  This means that while your balance is unlikely to fall further, it also means the loss is crystallised, and you lose the opportunity to ‘bounce back’ when markets recover.   

The FMA took a look at how investors reacted to the market fall in March 2020 and found that some people – particularly young people – switched funds after the fall. 

Read the FMA KiwiSaver switching research

If your balance drops and you do start to freak out and are not sure what to do, contact your investment provider or ask for help from a financial adviser. 

And remember to watch out for scams!  During periods of market volatility scammers will be working hard to play off your emotions. Be careful of anyone offering you ‘risk free’ or guaranteed returns. 

Read more about how to deal with a market fall here

Read more about how to recognise a scam


Additional resources