It might be fun to chase the 100% plus returns, but it often ends in tears. A steady 5% p.a. return is better than a lumpy stressful 5%.
In some shape or form we all have money that is at the mercy of the stock markets whether it is our pension and/or savings. Choosing the “right” investment can be tricky and even when we think we have the right blend something happens that makes us question what we are doing.
It is the old argument that if investing was easy everyone would do it!
There are, we believe, three simple rules to investing:
- Do not buy or sell specific stocks (unless you have the time and experience)
- Put your money in many countries, sectors and asset classes
- Don’t panic when all around you are panicking
Do not buy or sell specific stocks
One the quickest ways to make money is to find that rare stock which then quadruples in value. We see them all the time because financial journalists talk about them. There are two ways to achieve this, firstly buy in at the start and/or buy a beat up stock.
The problem is that for many finding that particular stock is very hard to do and it is easy to give up when things don’t seem to be working.
An example of this is holding shares in the UK around the time of the BREXIT vote. As the events on Friday unfolded certain stocks were punished – Barclays and Lloyds both down over 20% but others like Randgold were up 20%. The reality being that holding money in specific UK companies would have created losses.
Only those with time and experience should hold specific company shares and they must be prepared to lose all or part of their money if something goes wrong! It is still possible to get exposure to these companies but through ‘pooled assets’ in collectives/mutual funds which further spreads risk.
Many countries, sectors and asset classes
It is very easy for investors to choose just one UK fund thinking it is a good decision, when actually it could be the opposite! For example, someone who invested in a fund that tracks the FTSE 100 in January 2000, up to June 2016 would have been nursing a loss of 5%!
When investing we believe that there should be a split between countries, sectors and asset classes. There is a good reason for this which played out with BREXIT. If you had a diversified portfolio with about 20% in the UK and the rest invested globally you may not have lost any money overall.
To explain, the S&P dropped 3% but the dollar gained 10% against the pound. This effectively meant the diversified portfolios gained 7% on that part of the investment. Obviously where the drop was greater than the gain in the currency, there would still have been a loss but this diversification ensured that currencies acted as downside protection.
When we look at sectors, small and mid-cap do perform differently to large cap. They are attractive to investors because of the potential for significant returns but equally they carry significant downside risk. Using BREXIT as an example on Friday 24th the FTSE 100 was down just over 3%, but the FTSE 250 down over 7%.
Using a wide range of countries, sectors and asset classes is an important part of investing.
Don’t panic when all around you are panicking
It is a fantastic feeling to watch investments grow, in fact we can become slightly “smug” believing that everything we touch turns to gold. When markets start falling it is much harder and it is at this point that we are tested. The temptation is to take money out. The problem with that is often we sell at the lowest point, locking in losses and then find it almost impossible to recover them.
To illustrate this, it is worth reading this note from Schroders:
“We looked at the FTSE All-Share, the broadest measure of the UK stock market, over a decent timeframe – the past 25 years. We then filtered the data to show the 20 greatest one-day falls and looked at what happened over the days and years that followed. On the worst day, during the depths of the global financial crisis on 10 October 2008, investors lost 8.3%.
However, one year later, the index had surged and returned 26%, including income paid through dividends, to investors. The returns continued: after three years the total return was 41% and after five years it was 87%.
The figures apply to those holding investments before the market fell. Those who bought at the low points on those days would have seen even greater returns.
Most of the worst days, were during the severe market turbulence of 2008. Look back to 11 September 2001, the day of the terrorist attacks on the US, and the fall was 5.2%, the eighth worst in the last quarter century. The market struggled in the years after that as the technology bubble continued to deflate, but after five years, it was 44% higher.
The most notable five-year gain following one of the top 20 worst days was 126% after a 5% fall on 28 February 2009, another episode in the financial crisis and shortly before the UK bank rate was cut to 0.5% and the Bank of England’s programme of quantitative easing was announced.
It’s worth noting the wild volatility that often follows a big one-day stock market fall. For example, in the 10 days after 27 September 2008, the sixth worst day, the FTSE All-Share lost 22%. Yet still, the total return was 61% after five years.”
The expression “don’t panic” springs to mind. If the research has been done by reliable sources, hold steady because history shows it will likely correct.
Although it is tempting to invest directly into shares of companies, only invest if you can afford to potentially lose money. Equally it is easy to invest in one fund which is a collection of companies, but investors will protect themselves even more on the downside by spreading investments across countries, sectors and asset classes.
It might be fun to chase the 100% plus returns, but it often ends in tears. A steady 5% p.a. return is better than a lumpy stressful 5%. So finally, however we invest things happen, markets go down as well as up, but at times of great stress sit tight as history shows it will come back!
Note: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.