Understanding Market Volatility: A Guide for Long-Term Investors

What is Volatility?

Volatility refers to the degree of variation in investment prices over short periods. Think of it as the weather: some days are sunny, while others might be stormy. Just as a few rainy days won’t ruin the year, a temporary drop in the market doesn’t necessarily affect your long-term investment goals.

For long-term investments such as ISAs, pensions, and diversified general investments, these short-term fluctuations are typically smoothed out over a 3+ year horizon.

Key Points:

• Natural Fluctuations: Market prices move up and down daily due to a range of factors—from economic news to investor sentiment.
• Long-Term Growth: Over a period of five to ten years, the overall trend for well-diversified investments has historically been upward. Market fluctuations, even if they amount to 5% or 10% drops in the short term, are less significant when viewed against your long-term goals.

The Long-Term Perspective

Historically, equity markets have shown that they can reward patient investors. By focusing on long-term trends rather than daily movements, investors can take advantage of the market’s overall upward trajectory, without succumbing to the pitfalls of trying to pick stocks that outperform the market. This is especially true for managed portfolios like Wahed’s that are designed to withstand temporary declines while aiming to capture long term growth.

Taking Advantage of Volatility

If you’re investing for the long term, does it really matter if markets are down five or even 10% today or tomorrow? What matters most is the state of the market when you plan to access your money—typically five to ten years down the line. Volatility can actually work in your favour:

• Buying Opportunities: When the market dips, stocks are available to buy for less than they were previously. This means you can potentially purchase shares at a discount.
• Historical Returns: Markets have historically achieved average returns of around 8 to 12% per year. For instance, take 2022 as an example — the Wahed Very Aggressive portfolio finished down around 10%, but the following year saw gains of almost 20% . Many investors may have missed out on these returns by not investing during the down market due to a fear of volatility.
• Strategic Risk Management: When you are nearing the time when you need access to your money, that’s when you could look into moving to a lower risk portfolio - like Wahed’s Very Conservative or Conservative portfolios. Until then, staying invested during short-term volatility may help you benefit from market recoveries and long-term growth.

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Chart Analysis: Wahed Performance (2019-2024)

This chart provides a comprehensive view of how various Wahed risk portfolios have performed from 2019 to 2024, covering everything from Very Aggressive to Very Conservative portfolios, alongside cash, inflation, and our Physical Gold portfolio. It serves as an educational tool to help you understand the dynamics of market volatility and the importance of a long-term investment perspective.

Key Insights

1. Balancing Risk and Reward:
   The chart shows that, historically, more conservative portfolios can help reduce risk and volatility which can help lock in profits when you approach the time you need to access your funds. In contrast, accepting higher volatility in the more aggressive portfolios can be beneficial if you are aiming for greater long-term returns. The performance differences between aggressive and conservative portfolios illustrate the classic risk-reward trade-off.
   
   
2. The Role of Cash and Inflation:
   Including cash and inflation in the chart adds another layer of insight. While cash tends to preserve capital in the short term, it may not keep pace with inflation over time, which can erode your purchasing power. This emphasises the importance of diversifying your investments to not only capture growth but also to combat the effects of inflation over the long run.
   
   
3. Rethinking Gold as a Safe Haven:
   Many investors assume that gold is a consistently safe investment that only appreciates. However, the chart shows that gold too experiences periods of volatility. The performance of gold reinforces the idea that all assets—whether they are equities, cash, or commodities—can fluctuate. The overarching message is that long-term holding is key, as historical trends suggest that assets generally grow over time when you ride out the short-term ups and downs.

This chart is a powerful reminder that while managing risk is crucial as you approach your financial goals, embracing a degree of volatility early on can lead to enhanced returns. Whether you are invested in aggressive portfolios, keeping cash on hand, or even holding gold, the principle remains the same: patience and a long-term perspective are essential. By understanding the interplay between risk, cash, inflation, and asset volatility, you can make more informed decisions that align with your financial objectives.

The Role of Diversification

A well-diversified portfolio is one of the best defences against market volatility. By spreading your investments across various asset classes and regions, you help ensure that a downturn in one area can potentially be offset or hedged by another.

• Risk Reduction: Diversification helps smooth out the performance of your overall portfolio.
• Balanced Exposure: It allows you to benefit from the growth potential of different markets while mitigating the impact of any single market’s volatility.

What Can You Do During Volatile Times?

• Keep a Long-Term View: Instead of reacting to daily market fluctuations, focus on your long-term investment horizon. Remember, the value of your portfolio over a decade is what truly matters.
• Remember Pound Cost Averaging: Consistent investing, even during market dips, can lower the average cost of your investments and position you for greater gains when the market recovers.
• Ask for More Information: We’re here to explain your portfolio’s strategy and help you understand how volatility fits into the broader picture.

Final Thoughts

Market volatility is an inevitable part of investing. If you’re planning to access your money in five to ten years, short-term dips should not be a cause for alarm. Embracing volatility can enable you to potentially buy investments at a discount, which could boost your returns over time. While it’s natural to worry during downturns, history shows that markets tend to recover—and often exceed previous levels.

For those nearing the time to access their funds, transitioning to a lower-risk portfolio can help take volatility off the table. But if your investment horizon is long-term, staying the course and capitalising on temporary market declines could be the key to realising your financial goals.

Invest wisely, keep calm, and let time work in your favour.

Frequently Asked Questions (FAQ)

Should I sell my investments if the market is falling sharply?

It might be tempting to sell when you see significant losses, but selling during a downturn can lock in those losses. Instead, consider your long-term goals. If your investment horizon is 5+ years, short-term dips can actually present buying opportunities rather than reasons to exit your position.

How do I know if a market dip is temporary?

Markets naturally fluctuate, and short-term declines often recover over time. Look at historical trends, which show that markets generally bounce back from downturns. If your investment plan is for the long term, a temporary dip shouldn’t derail your strategy.

Should I consider buying more during a downturn?

If you’re comfortable with the risks and have a long-term perspective, buying during a downturn can be a smart move. By investing more when prices are lower, you may benefit from greater growth when the market recovers. This is often referred to as “buying the dip.”

I’m feeling anxious about the market’s performance today—what can I do?

Anxiety during market volatility is completely normal. Instead of making immediate decisions, take a step back and review your long-term investment strategy. Consider speaking with our team for reassurance and guidance. Remember, market fluctuations are part of the journey, and staying focused on your long-term goals is key.

What if I’m unsure whether my risk level is appropriate for my current situation?

If market volatility is causing you discomfort, it might be worth reviewing your risk profile. As you approach the time when you need your funds, shifting to a more conservative portfolio can help reduce risk and volatility

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Disclaimers: 

Intended for UK Audience. Capital at Risk.

This is information – not financial advice or recommendation. As with any investment, a Wahed Invest Ltd investment puts your money at risk, as the value of your investment can go down as well as up.If you are unsure about whether investing is right for you, please seek expert financial advice. Wahed Invest Ltd. is registered in England and Wales (Company No. 10829012), registered office: 87-89 Baker Street, London, W1U 6RJ, UK and is authorised and regulated by the Financial Conduct Authority: FRN 833225. 

Past performance is no guarantee of future results. Historical returns, expected returns, and probability projections are provided for informational and illustrative purposes only and are not an indication of future performance. All investing involves risk and you could get back less that you have invested.