Investing, while not usually a hazardous activity, can provoke strong fears and emotions, particularly when markets are falling and your investing pot is decreasing rather than increasing. The most confident, successful and outgoing people can completely lose their nerve at the first sign of a market correction, even though they may have taken large risks to achieve their own personal success.
On the other hand some people have an almost zen-like calm when it comes to making personal investments, even when experiencing sizeable short-term losses. Ultimately, not everyone is able to keep calm under pressure, but there are ways of improving your likelihood of doing so if you just follow a few simple rules.
Don’t take excessive position sizes
A day trader might open an FX position today on EUR/USD, and unless they were unlucky and opened the trade by chance on either the high or the low of the day, there would always be an opportunity to close it out at a profit at some stage. But if that trader took too large a position, he or she would face the risk that the market moved against them temporarily and they could not afford to keep the position open long enough to wait for a recovery.
Investing is no different. The larger a position size in any one investment, the more of a threat it is to an investor’s overall financial wellbeing if the investment does not immediately become profitable. As it’s very difficult to predict the short-term direction of the markets, it helps to approach every investment with the expectation that you will lose some money in the short to medium-term.
Embrace market corrections
Only in financial markets do we continually celebrate higher and higher prices. Yet thinking about it rationally, when you are accumulating your wealth, what you really want are low prices i.e. stocks temporarily on sale. High returns today simply borrow from tomorrow’s gains.
Each time there is a sharp sell-off, bargains arise, but you can only take advantage of them if you have spare cash or if your portfolio is sufficiently diversified. A diversified portfolio will see some of your investments rise in value, or not change much at all, while prices fall around you. An investment manager will rebalance your portfolio, helping you to sell the outperformers and buy the underperformers.
Watch: Investing: the power of diversification
If you are able to save regularly, such as in a SIPP or an ISA, doing so will smooth your investment returns over time. On a long-term chart, all equity market corrections, including the famous 1987 crash, become but the smallest of wrinkles.
Think like an investor, not a trader
Almost all investors have their favourite short-term trading ideas, which should make up a smaller part of their wealth, but this must not be confused with investing. Investing is about the steady accumulation of value, and is not a get rich quick scheme. Over the past 100 years UK equities have returned roughly 5.5% a year above inflation. If you believe that the global economy will continue to grow, innovate and reward investors with long-term returns, then investing is for you.
The best way to ruin your long-term returns is by selling at a low, and buying when markets recover. By all means time the markets with the trading pot, but resist doing so with the investment pot.
Read: Do trade your best ideas, but don’t mismanage your wealth
Look at percentages, not pounds
As you get older, your investments (and retirement savings) should start to multiply. When markets correct this will mean that their monetary value will be subject to large fluctuations. Resisting looking at your investments too frequently will reduce your temptation to panic sell, and by thinking always in terms of percentages the numbers will be rather smaller.
Ultimately percentages are what matter, as they answer the crucial question of what percentage of your savings and investments you can afford to spend every year in retirement before they run out. If you expect your investments to grow by X percent and your drawdowns to be Y percent, then you have the answer.
Read: Which will survive the longest: you or your pension pot?