4 reasons why you should keep calm and focus on your investment strategy
It can feel easy to invest when the stock market is performing well. Prior to the COVID-19 stock market crash, developed markets enjoyed an 11-year “bull run” since the 2008 Financial Crisis. Later in 2020, however, stocks quickly recovered the ground lost in March as investors drew increasing confidence from government support measures (e.g. furlough) designed to buttress the economy. More recently in 2022, many investors have felt more nervous. The S&P 500 went into “bear” territory after dropping more than 20% since the start of the year, and the Dow Jones Industrial Average (DJIA) fell 18.78%. The Nasdaq Composite fared worse, falling 33.70% since January. The UK market has fared better, although the FTSE 100 can hardly be said to have grown in 2022. Despite all of this uncertainty, it is wise to keep contributing to your investment strategy. Below, we explain why.
The case for cash
When the economy and markets are uncertain, many people are drawn to the “safety” of cash (which does not fluctuate with stocks). Cash can certainly be a useful asset class in specific situations. Easy-access savings, for instance, are often ideal for an emergency fund (e.g. 3-6 months’ worth of living costs) in case you lose your job or are faced with a sudden outlay, such as a costly home repair. Cash can also help achieve short-term financial goals like saving for a mortgage deposit.
However, cash is vulnerable to inflation and thus leads to a real-term loss over time. In 2022, UK inflation currently stands at 10.1%, yet easy-access savings accounts may offer between 2-4% at present. Therefore, if these figures were sustained over time, a saver could lose 6% or more of the buying power of the cash value despite the interest they are earning. With the UK economy as it is, therefore, investors are really faced with two choices: 1. make a near-guaranteed real-terms loss with cash savings; or 2. take a certain level of risk with investing to achieve a higher potential return (which could beat inflation).
Drip feeding vs. lump sum investing
For many, gradual contributions to an investment portfolio (e.g. from a salary) is their primary option. Others, however, may have a lump sum ready to invest. How should this be committed to a portfolio, particularly when the economy is uncertain? Some studies suggest that making a single lump sum investment could outperform drip-feeding the money into a portfolio over time. However, this is not guaranteed and investors need to consider how they would act if markets suddenly crashed shortly after committing their money.
The advantage of drip feeding (or “pound cost averaging”), perhaps on a monthly basis, is that you mitigate the risk of a market crash disproportionately damaging your portfolio in the short term - possibly causing investors to pull out their money and crystallise losses. Indeed, should the market “crash” during the investment period, this could offer an opportunity to buy shares “on the cheap” in the hope that your returns are amplified if (when) the market recovers. This is a helpful reminder to investors not to purely see economic uncertainty in a negative light. It can offer opportunities, too.
Goals, timeframe & risk tolerance
If, as a general rule, individuals should avoid holding large sums of cash when the economy is struggling, where should they invest their money? Here, there is no one-size-fits-all approach. Your goals and timeframe play key roles in shaping your investment strategy. This will depend on your objective and time horizon. If you are saving for your retirement you may well take a different approach from someone who needs their investments to support their day to day living costs. It is also important to take your risk tolerance into account. What investment volatility can you cope with, in practice? It is easy to overestimate how much you can tolerate (or underestimate), so working with an experienced financial planner can help you ask yourself the necessary questions to determine your risk profile.
Beware of timing the market
Should you avoid certain assets, sectors or companies when the economy is uncertain? Here, a balance often needs to be struck. On the one hand, investors need to be careful not to slip into trying to “time the market” (e.g. putting more money into energy companies in the hope that oil prices continue to rise). Predicting market forces and outcomes is very difficult to achieve, even for professional fund managers. Generally speaking, retail investors do better by spending time in the markets over the long term. However, this is not to say that current economic conditions should not play a part in your asset allocation.
Portfolio rebalancing is a case in point. Over time, your asset allocation (e.g ratio of shares to bonds) is likely to change as your investments vary in performance. When you meet with your financial planner - e.g. every 12 months - it may be time to sell and buy certain investments to rebalance everything in line with your goals. Here, various economic factors can play a role in determining your choices (e.g. interest rates, inflation, taxes and official forecasts). Doing this alone can be a challenge, however. Working with a financial planner can help you stay appropriately diversified and get the best out of your long-term strategy.
Get in touch with your usual Punter Southall Aspire financial planner to discuss your investment strategy.