Shares with a record of low volatility may hold up better and rebound faster from unsettled conditions.
A heady mix of coronavirus and an oil price war has sent markets into a tailspin this week. On both fronts, the near-term outlook for equities is far from clear. But there’s also a sense that decisions made at moments like this can have a significant bearing on your long-term returns.
This week, for example, there was an eye-catching note from Slater Investments, the small-cap fund manager run by the widely-admired Mark Slater. In it, he said:
“It is worth bearing in mind that the tendency of investors to sell on bad news is nearly always detrimental to long term financial gain. It pays to look through the short-term ‘noise’ and hold on through periods of uncertainty for superior medium to long-term gains.”
For what it’s worth, Slater says he a buyer of shares in these markets (although he’ll be doing that “sensibly” (ie. not in one go)). But it’s fair to say that not all investors share his steely nerve.
Indeed, in spells of panic and volatility we’re all prone to making bad choices because of natural biases and emotions. Here are a few to watch out for...
1. Action bias (patience is a virtue)
Faced with a penalty, goalkeepers who stay rooted to the spot save more goals than those who dive one way or the other. Yet being seen to make an effort is the reason why most will leap left or right. This is action bias… in action. When the optimal strategy is to do nothing, it can feel much safer to do ‘something’, whatever that might be.
Faced with falling markets, the instinct for many is to try and trade their way out of trouble. An urge to re-take control when others are losing their heads can lead to instinctive decision-making and costly over-trading.
The antidote is patience and planning. Having a pre-prepared strategy to deal with sudden sell-offs could save you from being caught up in short-term mayhem.
2. Recency bias (think long term)
No-one knows how serious coronavirus will turn out to be, and opinions are divided. But what’s beyond doubt is that the market sell-off in recent days was very sharp. And it’s that recent experience that’s likely to be shaping the views of investors right now. This is recency bias.
Recency bias is what happens when investors make assumptions about the future based on what’s just happened. When trends turn negative, the recent experience of falling prices can lead investors into thinking they will keep falling. This can escalate to panic selling as more and more investors react to the market action.
Things may or may not get worse, but history shows that stock market volatility evens out over longer periods - which is why it pays to think long-term.
3. Regret aversion (don’t be paralysed by indecision)
When circumstances or luck lead to an unsatisfactory outcome, the emotion you feel is disappointment. But when your own decisions lead to an unsatisfactory outcome, what you’re faced with is regret.
Regret aversion is the anticipation of making the wrong choice. It’s a cognitive error that can lead to indecision and inaction because of a fear of personally being responsible for making the wrong choice.
In volatile markets, regret aversion is only a risk when investors don’t have a plan. Being prepared about what to do in a sudden downturn or bear market takes away the potential for indecision and the chances of making the wrong choices.
4. Illusion of control (be realistic)
Research shows that people tend to be excessively over-confident in being able to influence chance events - and when it comes to investing, that can be costly. Indeed, overconfidence is widely seen as one of the biggest flaws in investors.
Impulse trading in the face of volatility might make you feel like you are controlling events. But in practice, it’s possible that all that trading - especially with no pre-planning or strategy - will be futile and simply rack up costs.
Rather than snatching at what could be ‘falling knives’ (stocks that seem cheap but keep falling in price) perhaps consider diversifying into less volatile stocks over time. Shares with a track record of relatively low volatility won’t be immune to market setbacks, but they may hold up better and rebound faster from unsettled conditions.
To give you an idea, here are 10 of the lowest volatility stocks in the market right now. They include some of the market’s best-known defensive names - including Diageo (LSE:DGE), Unilever (LSE:ULVR), Rightmove (LSE:RMV), GlaxoSmithKline (LSE:GSK) and National Grid (LSE:NG.):
|Name||Mkt Cap (£m)||Risk Rating||Relative Strength % 1y||1 Year Volatility %||Forecast PE Ratio|
|Croda International (LSE:CRDA)||5,712.30||Conservative||6.59||21.65||23|
|National Grid (LSE:NG.)||32,739.30||Conservative||25.4||21.84||15.3|
|National Express (LSE:NEX)||1,793.10||Conservative||-1.75||22.16||9.5|
|Wm Morrison Supermarkets (LSE:MRW)||4,244.90||Conservative||-7||22.24||12.8|
Managing your mind
To combat behavioral biases, it is worth having a pre-prepared plan or checklist that equips you with ready-made decisions. That might cover:
● A plan of action for both up markets and down markets
● Play devil’s advocate with investment ideas
● Seek out contrary views and evidence that an investment case has changed
● Be objective and beware of the risk of taking impulsive decisions
When markets tumble and panic sets in, a strategy like this could avoid the impulsive trading decisions that come from subconsciously trying to control the situation.
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