What is market volatility? A guide to why prices go up and down

George Mitton


3 min read

Every investor hopes the value of their investments will increase over time. But sometimes the value of an investment falls, stays flat or appears to jump up and down. When investment values change fast, it is said that financial markets are volatile. But why does market volatility happen?


In this video, Brad Holland, Nutmeg’s director of investment strategy, explains why investments are subject to market volatility and what that means. He uses the example of the FTSE 100, an index of the top one hundred companies that have listed their shares, otherwise known as stocks or equities, on the London Stock Exchange.

Is it normal that the value of my portfolio has gone down?

The simple answer is yes, volatility is normal for financial markets. Many things can influence the value of shares – and other assets such as bonds. Earnings reports, central bank interest-rate policy, elections, wars and natural disasters are a few.

The important thing to remember is that although the value of your investments may fall in the short term, evidence from history suggests that in the long term they are likely to rise1.

James McManus, head of ETF research at Nutmeg, has shown it is common for the FTSE 100 to lose at least 5% of its value during a year and yet still end the year higher than it began.

Read more: Why choosing not to change portfolios is an active decision

What should I do about market volatility?

It is natural to be unhappy about market volatility and want to do something to protect yourself against it. But the truth is that unless your investment goals have changed, the best response to volatility is to do nothing.

That, at least, is what the majority of Nutmeg customers do – or rather don’t do. We looked at five events going back to 2012 to see if Nutmeg customers changed their behaviour in response to market volatility. An average of 97.8% of Nutmeg customers did nothing out of the ordinary.

The finding is that Nutmeg investors, and likely investors in general, behave in line with their own investment goals, even when the going gets tough.

Read more: What do investors do during market volatility?

What is Nutmeg doing to protect my portfolio from market volatility?

It is the job of the Nutmeg investment team to manage your money. During periods of volatility we are as busy as ever – but we do not substantially change our process in response to short-term volatility because we know it is a natural part of investing.

In fact, the investment team take a six to twelve-month perspective and avoid being distracted by short-term movements, or “market noise”.

Although the team try to smooth our customers’ investment journeys, they don’t try to get rid of volatility. Instead, they spend time checking whether their underlying investment thesis is holding.

Read more: What we do during market volatility

Why can’t I invest in assets that aren’t volatile?

The answer is that you can, but then you are unlikely to be able to generate the return you need to meet your investment goals. Keeping money in a cash savings account may make you poorer in the long term due to inflation.

It may feel painful when the value of an investment drops, but diversified investing is all about putting your capital at risk across different markets and geographies to obtain a good return.

The rule of thumb is: no risk, no return.

Read more: The four investing rules everyone can rely on – and what to do about them

Can I time the market to cut out losses caused by market volatility?

Every investor would like to sell their shares the day before the market falls and buy them again the day after. But by trying to anticipate falling share prices like this, investors are liable to miss out on positive returns, and may end up worse off than if they stayed invested.

Research shows that jumping in and out of the market can lead to missed opportunities. Our investment team found that, in the 20 years ending 31st December 2016, the UK stock market returned an average of 13.9% a year, not taking into account investment fees.

If you had missed the ten best days over that period, your return would have been just 7.1%.

Read more: The six principles of investing everyone should know

Any more questions about market volatility?

This page is meant as a guide to market volatility containing links to our investment team’s writings on the subject. We aim to update it whenever we publish new information.

We hope these resources have answered some of your questions. If you have further queries please feel free to contact our customer service team.

Sources

  1. A detailed study by professors at the London Business School has found that, globally, shares have rewarded investors with a real or inflation adjusted rate of return of just over 5% since 1900. These figures are from the Credit Suisse Global Investment Returns Yearbook 2019.

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance and forecasts are not reliable indicators of future performance.

 

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George Mitton

George is the investment writer at Nutmeg. He has ten years’ experience in financial journalism, including as deputy editor of Funds Europe magazine. He has edited magazines covering financial markets in Asia and the Middle East and spent three years working as a journalist in the Gulf. George has a degree in politics, philosophy and economics from Oxford University.


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