Smarter Investing: managing your wealth wisely in a market crisis

Large intraday falls in the stock market can be alarming and prompt some investors to sell holdings to protect themselves from further losses. However, fluctuations in equity prices are common and investors who are able to not only weather the storm but use corrections in the market as a buying opportunity are well placed to see strong capital appreciation over the long term.

The value of investments can fall as well as rise, and you may get back less than you invested. Past performance is no guarantee of future results

On 24 August 2015, Chinese stocks plunged 8.5% on the day amid growing concerns that government intervention would fail to prevent a deepening rout in the Chinese stock market. The market had already fallen 30% over the previous two months, triggered by a series of currency devaluations by the Chinese authorities. In response to the 24 August drop, equity markets in Britain, France and Germany all fell around 5%. The selling continued into the US session with the Dow Jones Industrial Average opening 1,000 points down.

Large daily falls are normal

These violent stock market declines left many investors unnerved, prompting many to flee to the sidelines to shield their capital from further losses. However, Chart 1 illustrates how these type of sell-offs are far from uncommon.

Chart: Largest daily gains and falls for FTSE 100 per calendar year

FTSE 100 gains and falls
Source: Bloomberg

The largest daily loss for the FTSE 100 in each calendar year since 1985 has averaged 3.7% – with 25 out of 33 years experiencing a daily fall greater than 2.5%. This highlights the fact that the drop in the price of the FTSE 100 on 24 August 2015 was very much “business as usual” in terms of the magnitude of the loss (-4.7%) relative to other years.

The 2008 Financial Crisis (-8.8%) and Black Monday in 1987 (-12.2%) seem to be the only two extraordinary events over the last 33 years where investors suffered a daily decline exceeding 6%.

Investing rule 101: Don’t sell at the bottom

Selling investments after large daily declines is almost never a good idea. Stock market panic, witnessed on the day of the China crash, often leads to investors irrationally locking in losses rather than avoiding them.

Table: Prices for the FTSE 100 Total Return Index since Black Monday

FTSE 100 Total Return
Source: Bloomberg

The table above shows how investors who sold a FTSE 100 index tracker or exchange traded fund (ETF) on the day of the Chinese crash and didn’t promptly re-enter the market would have missed out on gains of around 6.7% over the rest of 2015. Any investor who sold on this date and didn’t reinvest until well into the 2016/7 bull-run missed out on significant gains.

Panic selling is largely driven by a psychological trait called loss aversion. Studies have found that for a large number of people, the psychological impact of potential losses is nearly twice as powerful as the impact of potential gains of the same size.

To make matters worse, there are always economic and financial events on the horizon that can scare investors into the thinking markets are likely to fall sometime soon. Be it the return of a European banking crisis, a slowdown in the Chinese economy, or war on the Korean peninsula… the list could go on and on.

Manage your wealth wisely and take a long-term view

Investors who are in the relatively early stages of accumulating a pot of money for an investment goal should not only be investing in the market on a regular basis, but using dips as a buying opportunity. This has the effect of pound-cost averaging, which you can read more about here.

IG has a range of five expertly-managed Smart Portfolios that you can invest in. In the Aggressive Portfolio – the highest risk portfolio – the intent to act upon such investment opportunities in equities is highlighted by holdings of ultrashort bonds. These are considered similar to cash and also counteract the long maturity in the UK gilts and Index-Linked bonds that are held in this portfolio.

For investors who are close to meeting their investment goal or fast approaching their investment time horizon, unexpected events that could potentially have a negative effect on equity values should be factored into asset allocation. Holding asset classes with a low correlation to equities such as bonds and precious metals should provide a cushion to such falls. The Balanced Portfolio currently contains 48% Equities, 48% Fixed Income and 4% Gold.

All types of investors should remember to remain focused on their specific investment goals; such as saving towards buying a first house, a child’s education or generating funds for retirement. The path to doing so can be an unsteady one, but investors who can confidently navigate fluctuations in equity prices and take advantage of corrections to the market are highly likely to succeed and meet their goals over the long term.

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