Key takeaways:

• In an inflationary environment where interest rates are rising, investors should regularly review their portfolios

• Uncertainty is one of the biggest obstacles for markets, which is why investors should manage for market risk, including the use of diversification

• Long-term investing means there will be market downturns from time to time, but that does not mean it is wise to try and time the market

As an eventful year comes to a close, it is an opportune time to take stock of key learnings from 2022. Much of the focus this year has been on rising interest rates and elevated inflation, which have weighed on the market.

However, these issues also go some way towards explaining key investment principles. Here are some important lessons that new investors should take away from this year events.

Rising Interest Rates Affect the Market in Different Ways

There has been no shying away from the fact that interest rates have dominated the narrative over recent months. 

Investors have been watching every move of both the Reserve Bank of Australia and the US Federal Reserve. Interest rates have increased rapidly as central banks tighten monetary policy at the fastest rate in decades.

Why has this been so important for the stock market?

Central banks lift rates in an effort to cool' the economy. Among other goals, the intent is to slow demand growth enough to unwind elevated inflation. However, an aggressive rate hike cycle also raises risks regarding an economic slowdown or recession.

Contrary to popular belief, rate hike cycles do not necessarily mean equity prices are destined to fall. However, when interest rates rise quickly over a short period, selling pressure often mounts.

Higher interest rates may negatively affect earnings and share prices in some sectors, yet prove favourable in other sectors. Additionally, future discounted valuations tend to be lower since the discount rate used for future cash flow is higher. 

This typically works against growth' stocks, while value' stocks often become more attractive. The key lesson here is that valuations generally become a bigger focal point as interest rates rise.

Recap what rising interest rates mean for the stock market.

Inflation May Change What is Popular in the Market

If rising interest rates are the defining theme of 2022, inflation would be right behind it. After all, central banks have been tightening monetary policy in response to multi-decade high inflation.

Although the jury is still out on whether inflation has peaked in the US, investors will note the role it has played this year.

Industries or stocks that have felt the effects of inflationary costs have been punished harshly. 

On the other hand, some sectors have performed well through the inflationary cycle, as they have shown historically. This includes banks and insurers, which are mostly up year-to-date, as well as energy stocks, which rank as this year best performers. 

Since energy prices are an input into inflation data, investors have visibility to gauge whether these companies stand to benefit.

At the same time, one of the key lessons from recent months is that inflation takes time to cool. Despite a series of rate hikes, inflation is still well outside the target ranges set by central banks. The longer inflation remains sticky', the more impact it will have on companies vulnerable to rising costs.

Overall, when inflation is high, it pays to look closely at the stocks and sectors you are exposed to, as sentiment can swing sharply.

Brush up on some popular inflation trades here.

Markets Hate Uncertainty

Investors may take note of the significant uncertainty that has prevailed in 2022. From the war in Ukraine, to interest rates, inflation, China COVID-zero policy, geopolitical tension, and even the global economic outlook - a number of issues have increased the risk profile of the stock market. 

Traditionally, the stock market does not like uncertainty. 

Not only does uncertainty give rise to volatility, but investors tend to seek out more defensive investments, including other asset classes. 

This year has proven to be no exception. At the first sign of uncertainty, investors have repeatedly pivoted to a risk-off mindset.

What this means is that you should be actively managing your risk exposure in the stock market to ensure you are prepared for any downturn.  

Learn about managing the risks of a market downturn.

Portfolio Diversification Can Protect Against Volatility

Although this year has been difficult for most investors, and the market at large, not every sector has been impacted.

In fact, some sectors have outperformed in 2022. Energy, utilities, and materials have all posted year-to-date gains, while every other sector is currently trading in the red.

Of course, the same principles extend to individual stocks within each sector, with some faring better than others.

The key takeaway here is that diversification can help your portfolio during a market downturn. Diversification can be used to manage risk and potentially reduce volatility. In some instances, it may also shield your portfolio from losses.

Read more about how to diversify your portfolio.

Long-Term Investing Means Ups and Downs

After a remarkable rally in 2020 and 2021, the stock market performance in 2022 has disappointed many investors.

However, it is important to remember that while the stock market tends to increase over time, sometimes there are setbacks along the way. Basically, the market does not always increase over the short-term.

Understanding this point is key. You can expect the market to decrease from time to time, but this in itself should not deter you from investing. Instead, you should view investing as a long-term practice, not an overnight rags-to-riches story. A longer investment horizon allows you to leverage the powers of compounding growth.

If you cannot afford to witness a market downturn from time to time, both financially and psychologically, then you might want to reassess your motives for investing in the stock market.

If you are a long-term investor, dollar-cost averaging is considered a disciplined approach to remain active in the market. By investing a certain amount of money into the market at regular intervals, regardless of what the market is doing, you remove emotion from your investing.

With this approach, you'll end up buying more shares when the market is low, and fewer shares when the market is high. Over time, however, being in the market, as opposed to trying to time the market, is considered one of the best ways to achieve sustainable returns.

Understand the principles of dollar-cost averaging here.

Final Thoughts

Although 2022 is likely to be a year that many investors in the stock market will want to forget, there is good reason to reflect on what has occurred. 

Whether it be shifting popularity across stocks and sectors amid high inflation and rising interest rates, or the anxiety that typically accompanies market uncertainty, there are important lessons to observe. 

In addition, this year should also serve as a helpful reminder as far as key investment principles surrounding the benefits of diversification and long-term investing.