Be proactive, not reactive
Markets will always go up and down – it’s their nature. But rather than responding to volatility, which can lead to ill-timed decisions, the key thing is to be proactive about it. This means choosing an investment strategy based on your risk profile.
Generally speaking, the longer your investment horizon, the more risk (short-term volatility) your investments can withstand because they have time to bounce back. We’ll return to this in a moment.
Another way to be proactive is to hold a diversified investment portfolio. But you don’t have to do it all in one go: for the time being, you can start building the foundation with a KiwiSaver plan. This brings us to the next point…
Use dollar-cost averaging
Instead of trying to time the market and making one-off lump sum investments, dollar-cost averaging means making regular contributions, at regular intervals, regardless of the ups and downs in the market.
For example, you may invest $200 each month in the same managed fund, rather than trying to time the market or follow investing trends. This way, you can take the guesswork out of buying a fluctuating asset. You’ll automatically buy more units or individual assets when prices are down and less when prices are up.
If you’re employed and invest in KiwiSaver, you already use this strategy. Every month your contributions and your employer contributions are added to your KiwiSaver account, and unless your contribution rate or income changes, the amount you invest is always the same.
Invest based on your risk profile
Your risk profile is made up of two components:
- Tolerance – your attitude to risk and how you feel about market volatility) and
- Capacity – how much short-term volatility your investments can withstand, typically based on your investment horizon and financial situation.
For example, if you have 30-40 years until retirement, it’s very important to invest with growth in mind, rather than focusing on protecting your money. Simply put, even if you are uncomfortable with market volatility, you may want to choose a higher-risk portfolio (e.g., growth or aggressive), to take advantage of higher potential long-term returns.
On the other hand, if you’re planning to use your savings (like your KiwiSaver funds) to buy your first home within the next two or three years, then ‘two or three years’ becomes your investment horizon. You will probably need to consider de-risking your home deposit investments until the keys to your first home are safely in your hands. After that, you can refocus your strategy on the long term.