Volatility in financial markets

Bonds from issuers with good credit ratings are considered relatively safe, low-volatility investments. Interest income is predictable. Price changes in traded bonds mainly result from interest rate changes: if the market interest rate rises, the price of lower-yielding bonds falls. If the remaining term (duration) is still long, interest rate changes have an even greater impact on the price. If the issuer becomes insolvent, the repayment of capital is at risk.

Equities are subject to significant price fluctuations. If a company cuts its dividend or lowers its earnings forecast, share prices often react sharply. Conversely, there are high profit opportunities when business exceeds expectations. How large the swings are depends very much on the expectations of market participants. These expectations vary between stocks from different sectors and types of companies. Established business models offer more predictable returns and are less susceptible to fluctuations than emerging growth companies with new technologies.

Commodity prices are highly volatile. Oil, copper, gold: depending on the commodity, economic, geopolitical or inflationary trends play a decisive role in price fluctuations. For agricultural commodities, harvest and seasonal factors also cause price swings. The effects of price fluctuations can be mitigated by inventories or commodity futures markets.

The fluctuations in real estate values usually follow different patterns to those of other asset classes. Real estate is therefore suitable for diversifying a portfolio of different asset classes. Inflation has little effect on the returns of rental properties, as rents can be increased. Direct investment in a single property carries a concentration risk, meaning high dependence on a single asset. This can backfire if the local market deteriorates or buyers are scarce. Risks can be spread by investing indirectly in real estate funds or real estate ETFs.

The value of cryptocurrencies fluctuates greatly. The prospect of large price gains with Bitcoin & Co. comes with the risk of total loss and dependence on regulatory and political decisions.

Leveraged products in the derivatives market offer very high profit opportunities, but also high risks of loss. Speculative investors can find warrants or certificates on this market. Others turn to hedge funds and private equity as ways to access alternative investments.

Your risk profile will show you whether you are risk-averse or risk-tolerant in your investments. It helps to identify suitable investment options. You should also determine an investment horizon, meaning the duration of your investment: the longer you can let your money work, the more likely you can offset fluctuations. This allows you to include more volatile, sometimes riskier, but more profitable asset classes in your portfolio.

You can diversify your portfolio by investing in several asset classes rather than just one. The advantage of this diversity is that the risks associated with individual investments also vary in terms of value fluctuations. Ideally, diversification balances out and reduces volatility, even if it may lower returns depending on market conditions. Options are an alternative way to protect your portfolio against major price swings.

Investment assets in a diversified portfolio do not all perform uniformly. This means that high-yield investments can become overweighted over time. Rebalancing allows you to regularly return the proportions of the asset classes to their previous percentages. You sell some of the assets that have risen sharply in value and increase your holdings in other asset classes.

Many investors want to avoid investments that are subject to significant fluctuations in value. They often confuse volatility, which only refers to the range of price movements, with the risk of loss. This view overlooks the fact that losses in share prices, for example, don’t have to be realized and can be offset over time, depending on your investment horizon. Since volatility also includes upward price swings, it also indicates potential gains.

Even an investment with low volatility can fail. Despite minor price fluctuations, there is still a risk that, for example, a government bond may not be redeemed at maturity.

To weather volatile market phases and use them to your advantage, you need sufficient income and reserves to cover your living expenses. This way you won’t feel pressured to sell when prices fall. If you have liquid capital at your disposal, you can use weak market phases to make additional purchases.