Stock markets are falling, but investors should hold their nerve
Investing is all about perspective. A sudden fall in share prices hurts the short-term holder, creates opportunity for those with cash, but has little consequence for the investor. Here we explain why investment managers rarely react to short-term movements.
There’s nothing like a market sell-off to strike fear among investors. Months of slowly accumulated gains can be rubbed out in a few manic days. Suddenly, after months of ignoring steady advances, the mainstream media wakes up with dramatic headlines screaming of plunging stock markets, and ‘1000 point losses’ on the Dow Jones, alongside the obligatory recycled photos of bank traders with their heads in their hands.
Rather than the frenzied activity you might expect during these periods, the proceedings in an investment management business are usually rather benign. A few more clients call in than normal, analysts write more notes, but there is little change to investment strategy.
The reason for this is twofold: firstly, market sell-offs are very frequent occurrences in the investment world, but are rarely driven by fundamental changes in the economy. And secondly, investment managers are employed to get the long-term asset allocations right, not to try and second-guess the daily movements of the stock markets.
Looking at a log chart of the FTSE 100 total return index, we can see that the most recent 8% sell-off is but the tiniest of blips on a long-term chart. Indeed the FTSE 100 fell by 22% between February 2015 and April 2016, something that almost everyone has forgotten.
For an investor, reacting to every market sell-off is unlikely to be a successful strategy; selling is easy, but knowing when to get back in is the tricky bit. The stock market volatility in the summer of 2011 (see chart 2) is a great example of when it paid to sit tight. The FTSE 100 fell sharply in August due to fears that the European sovereign debt crisis would spread to Spain and Italy, and thereafter showed extraordinary volatility for a two-month period, with several market rallies and drops greater than 5%. Yet a mere six months later the market had recovered all of the losses.
Timing this market was nigh on impossible, with rallies and reverses often caused by statements from politicians and central bankers. Many investors would have been whipsawed, buying at the top and selling at the bottom of each market lurch. However, long-term holders were able to wait out the volatility in the expectation that the global economy would grow, companies would increase their profits, and shareholders would ultimately be rewarded for taking on equity risk.
The examples above illustrate the return profile that someone investing solely in the FTSE 100 could have experienced. However, investment portfolios are rarely 100% invested in equities, and certainly not 100% invested in just one market. Portfolios following a ‘balanced’ or ‘growth’ strategy would use other investments with different return profiles to add diversification to their returns.
For example, bonds are usually negatively correlated to equities. This means that when equities fall, bonds can act as a shock absorber in your portfolio by making gains. Similarly, if the pound was to fall then gold and holdings denominated in foreign currencies can provide some protection.
In contrast to what the media often portrays, investing is not a high octane activity and it is certainly not gambling. The asset class risks we take in IG Smart Portfolios are all measured ones, designed to pay the owner in the medium term, with returns suitable for the amount of risk that they are willing to take.
Our clients should rest assured that the core of their savings and investments are being sensibly and professionally managed at a low cost, allowing them (should they wish to) to research and profit from other areas of the market that they have a greater expertise and knowledge in.