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

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

Is it normal if 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 bonds. Earnings reports, central bank interest-rate policy, elections, wars and natural disasters are a few such influences. More recently, worries around the spread of Covid-19 and its impact on the global economy have also led to market turbulence.

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 rise.

In a previous blog, James McManus, Nutmeg’s chief investment officer, has explained how 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.

I’ve read about a market crisis. Should I be worried?

The word ‘crisis’ is often used by journalists, but bear in mind that these volatile periods come in different shapes and sizes. Just because a situation has been described as a crisis doesn’t necessarily mean it will have a severe, long-lasting effect on your investments.

Of course, markets do sometimes suffer big crises, but you might be surprised how common they are. We looked at the data and identified 13 major crises since 1990. On average, that’s one every two and a half years.

Investors can face a high frequency of crises and still make good investment returns over the long term.

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 often to do nothing.

That, at least, is what the majority of Nutmeg customers do. We looked at seven events going back to 2012 to see if Nutmeg customers changed their behaviour in response to market volatility. An overwhelming average of 97.8% of Nutmeg customers did nothing out of the ordinary. Nutmeg investors, and likely investors in general, behave in line with their own original investment goals, even when the going gets tough.

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

It is the responsibility of the Nutmeg investment team to manage your money. During periods of volatility they are focused on this, but don’t necessarily change processes in response to short-term volatility because they recognise it is a natural part of investing.

In fact, the investment team take a six to 12-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.

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 reduce the purchasing power of your money 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.

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’d stayed invested.

Research shows that jumping in and out of the market can lead to missed opportunities. Our investment team found that, between January 2000 and December 2021, the UK stock market returned an average of 4.6% a year, not taking into account investment fees. If you missed the ten best days over that period, your return would have been just 1.5%.

What can we expect to happen in 2022?

The year 2022 has so far been a volatile period for risk assets, with equity markets reacting to rising interest rates, and indications of a gradual easing of central bank monetary support – particularly the buying of government bonds – by the likes of the Bank of England, Federal Reserve, and European Central Bank.

Russia’s incursion into Ukraine has also added to investors’ unease, with energy markets most likely to bear the brunt of any escalation in tensions or full-scale invasion. Geopolitics are never far from investors’ minds but by their nature they are unpredictable.

When investors rapidly re-assess their positioning, volatility is to be expected, and it’s typically the most exuberant and speculative parts of financial markets that need to re-adjust. This re-assessment also commonly impacts sector and country exposures. Although uncomfortable in the short term, it can also present opportunities as well as risks.

Any more questions about market volatility?

This page is meant as a guide to market volatility, containing links to our investment team’s further views 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.

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.