Turbulent times – where next for investing?
Falling stock markets, falling commercial property values, banks failing and even countries appearing to be bankrupt……could it really get any worse? Yet for most people is this really the disaster the media would have us believe?
Undoubtedly times are extremely turbulent, and we are experiencing events not seen for many decades if at all before. But for savers and investors what does it really mean?
More than ever before, understanding risk and reward and having an investment strategy in line with your own risk profile is crucial. And certainly you shouldn’t adopt someone else’s strategy and assume it’s good for you. After all, what’s right for Angela isn’t necessarily right for Gordon!
Nor is this approach a “one-time” exercise. Risk profiling and investment portfolios need regular reviews – at least every couple of years.
But what do we mean by risk profiling? In essence this is a method of determining an individual’s risk ranking within the context of an investment objective. For example, when investing for retirement some 30 years hence, one might be less risk-averse than if saving for school fees payments in 5 years’ time.
In turn, this drives the design of an individual’s investment strategy i.e. what mix of the different asset classes (e.g. equities, commercial property, bonds, gilts and cash) should I hold? The underlying principle is that a good spread of investments across different asset classes provides more stable, and therefore better, long-term returns.
Equities as an investment
But in the current climate, should equities remain a part of the investment portfolio? History has shown us that, over the medium to long term, equities provide real value. However, trying to second-guess market moves by switching in and out of equities is potentially fraught and most investors who try it are worse off as a result. Let’s illustrate this with an example:
A stake of £1,000 invested in the UK stock market 15 years ago and left untouched would have grown to be worth £3,261 in June 2008 (assuming dividends were re-invested). Market statistics (1) show that if you missed the ten best days in the market since June 1993, then the stake would be worth a great deal less - £2,147. Strip out the best 40 days and the value falls to just £885. And some of those best days are likely to come in the very early stages of market recovery, just when many investors are sitting in cash and still reeling from their losses.
Clearly, equity investment rewards the patient investor who will benefit from the long-term, upward trend. However, if the investment horizon is less than 5 years or so then significant equity holdings are likely to be too risky.
Regular Savers
What of regular savings or pension contributions? Should we be avoiding stocks and shares? Actually, no. For regular savers the benefits of pound cost averaging are significantly increased in a falling market.
The benefits of pound-cost averaging
| Month | Unit price | No. units (monthly purchase) | No. units (lump-sum purchase) |
| January | £1.11 | 90.1 | 1,081 |
| February | £1.11 | 90.1 | 0 |
| March | £1.10 | 90.1 | 0 |
| April |
£1.14 | 87.7 | 0 |
| May |
£1.12 | 89.3 | 0 |
| June | £1.10 | 90.1 | 0 |
| July | £1.02 | 98.0 | 0 |
| August | £0.91 | 109.9 | 0 |
| September | £0.92 | 108.7 | 0 |
| October | £0.82 | 122.0 | 0 |
| November | £0.86 | 116.3 |
0 |
| December | £0.91 | 109.9 | 0 |
| Total units | 1,202 | 1,081 | |
| End value | £0.91 |
£1,094 |
£984 |
Clearly, investing regularly in this volatile and falling period would have resulted in buying more shares for the same outlay. The average purchase cost for the monthly investor would have been 100p, whereas for the lump sum investor it would have been 111p. And the monthly investment is better placed to profit from an upturn, having 11% more units from which to profit.
Other asset class investments
Is the picture the same for other asset classes? Quite simply, yes. It is equally difficult to call the top and bottom of the market in any asset class.
Take high-yield bonds (a form of fixed-interest investment). In the calendar years 2000, 2001 and 2002 they produced a negative return each year. By then you’d be forgiven for thinking enough was enough and switched your investment from them. Yet in 2003 and 2004 they were the second and top performing asset class respectively, returning 39.5% in 2003 and 21.2% in 2004 (2). The patient and diversified investor who remained invested partly in high-yield bonds in this period would have benefited from the upside, while the short-term investor would undoubtedly have missed out. This picture is the same for many other asset classes.
What of cash? Using the same data, cash has returned between 3.6% and 6.2% per year between 2000 and 2007 - a pretty consistent performance. But how does it rate alongside other asset classes? Well, out of 14 different asset classes between 2000 and 2007, cash returns rank 5th, 3rd, 5th, 13th, 13th, 14th, 9th and 7th respectively (3). Now, looking at these rankings, you could argue that returns from cash have been very volatile against other investment groups – and volatility isn’t something we normally associate with cash returns!
Time is a great friend to the investor. Many investments, whilst volatile in the short term, can offer good returns in the long run. On the other hand, an investment where the return is fixed, e.g. cash, may be low risk in the short term but higher risk as a long-term investment because of its inability to outpace inflation.
The best way of avoiding boom and bust cycles is to make objective decisions with a long-term view of how different asset classes have performed. And certainly ignore current investment fashions.
So what now?
Is your investment ship holed below the waterline? Is it time to abandon ship and dive into the choppy waters? We think not.
Instead, it’s time to hold your nerve, review your strategy and navigate a route to smoother waters with these steps:
- Review your risk profile(s) – how risk-oriented am I now?
- Review your existing investment portfolio against your risk profile(s) – am I invested in the right types of asset for my risk appetite?
- Re-balance your portfolio to reflect your risk profile(s) – sell some holdings and buy others
- Make a diary note to repeat this process at least every couple of years
And if you’re not getting one-to-one advice from a professional financial adviser, speak to Aspira. It’s just too important to get wrong.
Derek Miles
Managing Director, Aspira Corporate Solutions LLP
October 2008
1 Source: Datastream 30/6/1993 to 30/6/2008
2 Source: Datastream and Morningstar; Total returns in sterling as at 02/01/08
3 Source: Datastream and Morningstar; Total returns in sterling as at 02/01/08
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