Many people believe that they can "time the market" - that is, get in before the prices rise, stay in while the boom is on, then get out before the prices fall.

Anticipating these market rises and falls can be extremely difficult because no two business cycles are the same. In practice, many market timers actually end up worse off.

This is why most financial planners recommend a diversified portfolio to help spread the risk; and you, the investor, must then allow time for higher returns in the long term and let the rises and falls of the market take their course.

The main message from investment experts is that it is better to buy and hold on to investments in the long term rather than try to "time the market". It is the time in the market that counts, not necessarily the timing.

Handling volatility and negative periods

If you get caught in a time of high market volatility with falling prices it is easy to panic and lose sight of the long-term view. Most investors are very uncomfortable with negative returns because they fear a further drop in the value of their investments.

These periods of low or negative returns are a normal part of most markets. In fact, it is important to expect some disappointing low returns in some years and high returns at other times.

Only those investors who sell will turn a short term loss into a permanent loss. History shows us that markets do recover but sometimes it takes a year or more.

The three important factors in handling these volatile periods are to:

• Stick with your long term goal;
  
  
• Protect yourself by spreading your portfolio across a range of investments that behave differently under different market conditions; and
  
  
• Match your objectives with realistic time frames. For example, if your long term goal is 30 years, you can easily ride out a five year market slump to gain the real benefit of building up your wealth and fighting inflation.

What about currency fluctuations?

If your investments are spread overseas, you may have some additional risk from adverse moves in the currency. However, these risks generally do not contribute greatly to the overall risk of a well-diversified portfolio. You should, however, be aware of the possible effects if a large part of your portfolio is invested overseas.

What can we learn from history?

Sticking with your strategy can pay off
Despite ups and downs, historically most assets have done well if held for the long term.

The ups and downs of trying to pick a winner
Market volatility can mean that while one type of investment is doing well, another may be performing poorly. In this situation, it is tempting to switch your money to the latest "hot" investment, but it is not always a wise strategy. The best performing asset changes from year to year. Good years are often followed by poor years. Poor years are often, but not always, followed by good years. In other words, chasing last year's top returning asset is generally a poor strategy.

Steadier returns from diversified portfolios
While a diversified portfolio is never the best in any given year, it can give good consistent long term returns with less volatility than other asset sectors.

Reproduced with the kind permission of the FPA & Macquarie Investment Management Limited.

©2000-2006 Forsyte Consulting Pty Ltd unless otherwise stated.