Help: I’m too scared to invest!

• Market ups and downs have left many investors nervous.

• We believe you should focus on your long-term financial objectives and make use of investment strategies that can help you ride out periods of short-term uncertainty.

The values of investments have varied markedly in the last two years, leaving many investors worried about committing their hard-earned savings.

And since the outbreak of the Covid19 pandemic, countries, cities, tows and businesses have had to close. Reduced production, wages and trade have led to the global economy slowing dramatically.

It is at times like this that many are tempted to keep their money on deposit until they feel more confident.

It’s been a rollercoaster

Frequently changes in the value of investments – known as volatility – is a common feature of investing and is a reflection of how confident investors are in the future.

It’s a measure of how frequently investors change their minds about a particular asset. Low volatility reflects a high degree of confidence and high volatility reflects a heightened sense of uncertainty.

So if you’re feeling nervous, recent volatility seems to indicate that you’re not alone.

It’s just history repeating itself

The history of investing has been punctuated by frequent periods of high volatility. Despite the longest continuous period of investment growth in modern times, uncertainty was high 2009, in late 2010, and again in 2017; and was relatively high from mid-2014 to the end of 2015.

Look to the longer term.

Rather than fret about short-term performance, we believe it is better to focus on the longer-term opportunities. After all, if you’re going to invest, you should only do so if you can afford to put your money away for at least ten years.

The waiting game: a dual-edged sword

There are two issues we should consider when taking a wait-and-see approach.

One powerful reason for not holding too much cash is the likelihood of it losing value due to the long-term effects of inflation: growth in the prices of goods and services over time. 

Chart 1 below shows the effect that different levels of inflation can have on the value of cash.

Whilst inflation has been close to 2% for much of this year it was as high as 3% as recently as January 2018 and was 5% in October 2011 .

Since the summer of 2018, increasing trade restrictions and the UK’s looming departure from the European Union have created expectations of higher import costs: in other words, higher inflation.

The second risk is missing the best days of the recovery when it comes. This is because it is notoriously difficult to predict how stock markets are likely to move over the shorter term. Markets can turn very quickly and these turning points are nearly impossible to foresee.

This type of strategy – second guessing the return of confidence to avoid potential losses – is called ‘timing the market’.

However, in trying to time the market there is a significant chance that we actually mistime the market and forego the best days of the recovery.

Chart 2 below shows what can happen if you decide to hold cash in the hopes of investing once you feel more confident.

It shows the effects of missing the best ten, 30, 60 and 90 days of the past twenty years. These need not be consecutive days. That might seem a difficult thing to achieve. Could you really miss the best sixty days?

There have been a dozen or so market cycles of varying length in the past twenty years. Missing just the first five days of each recovery, wondering whether to invest or not, could easily lead to you missing sixty days in total.

Steady does it

There is an investment technique that can be ideal for this situation.

It is known as pound-cost averaging. It means contributing small amounts of money at frequent and regular intervals rather than making a single large lump-sum investment.

The theory is when share prices are fluctuating you might buy some shares at a higher price, and some at a lower price. Over the investing period you will achieve something between the two.

In this way you attempt to neutralise the short-term effects that come with frequent swings in the value of investments, because only a part of your total investment is exposed to potential losses.

It isn’t always the most profitable way of investing over the longer-term but if your focus is on minimising losses it is a way of capturing some of the ups whilst minimising some of the downs.

Of course, you might still experience some of the losses and miss out on some of the gains, but this technique can be a good way of avoiding major short-term losses.

Stabilising investment returns

Investors concerned about volatility usually focus on one asset class; equities. There is another investment tool that seeks to reduce the variability in investment portfolios to reduce the extreme highs and lows of performance.

Diversification is the strategy by which investors attempt to optimise the amount of return they can potentially achieve given the amount of risk they want to take. They do this by spreading their investments across a number of different assets such as equities, bonds, and property both at home and abroad.

This approach seeks to smooth out performance by reducing exposures to the different types of risk unique to each asset class. The aim is to counter the negative performance of some investments by the positive performance of others.

This is because different investments perform well in varying economic and market conditions and asset classes tend to react differently to the same economic or political events.

Conclusion

Volatility is nothing new and a frequent feature of investment performance. But that doesn’t make it any the less-comfortable.

It is completely natural to want to shy away from the potential pain of short-term losses. But holding significant levels of cash can see the relative value of our wealth eroded by inflation.

We believe that looking at your longer-term financial goals, phasing your investments, and maintaining a diversified portfolio can help assuage your fears.

Ignore the storm around you and keep your eyes on the horizon.

*FXStreet correct as at 2 September 2019

Forecasts of future performance are not a reliable guide to actual results in the future; neither is past performance a reliable indicator of future results. The value of investments, and the income from them, may fall as well as rise and cannot be guaranteed and the investor might not get back their initial investment.