How much risk are you taking?
- 01 April 2020
- 5 mins
Committing to investing our hard-earned wealth can make any of us feel anxious.
Especially when markets are unstable.
But the alternatives to investing bring their own challenges.
Every investment decision bears an element of risk. As we shall see even deciding not to invest comes with its own level of risk. With markets around the world continuing to prove unpredictable it is not surprising that some investors are increasingly concerned about when might be the ‘best time’ to invest. Many may decide to hold off from making any investment, choosing to keep their money on deposit waiting to see what happens before committing themselves. They hope to spot the exact moment that company shares begin to recover before reinvesting. However, predicting stock market moves over the short-term is extremely hard. Even professional investors can get caught out. Markets can turn very quickly and these turning points are nearly impossible to predict. The danger in trying to time the market is that we actually mistime the market and forego the best days of the recovery. Chart 1 shows the effects of missing the best 10, 30, 60 and 90 days of the past 20 years. So if it's hard, or even impossible, to spot the right time to get into or out of markets, what can investors do if they are concerned about short-term setbacks? We believe that remaining invested at all times allows us to capture the rapid recovery phase that, historically, has frequently followed a downturn.
If you missed the 30 best days between 31 March 1999 and 31 March 2019, an investment in a FTSE All Share index fund would have fallen by 65% instead of rising by 37%
This is illustrated in Chart 2 which plots the daily returns of the same index for the past twenty-odd years.
If you are interested in investing but have concerns about the uncertainty of returns, please speak to your Personal Wealth Adviser.
The periods highlighted in orange represent market corrections: when markets fall by more than 10% but less than 20%. The periods highlighted in purple represent periods where the index has fallen by more than 20%, often referred to as a ‘bear market’. It shows that market downturns are more frequent than many investors realise: in the last twenty years there have been five periods when UK share prices have fallen by 10% and four when they have fallen by more than 20%. It also illustrates how each market correction and each bear market has usually been followed by a recovery that leads the stock market to new highs. For despite these downturns, the long-term trend (over ten years or more) is for share prices to appreciate. Compare the index values at the start of 1998 with those at the start of 2008, and those from the beginning of 2009and 2019. With the exception to the Great Recession of 2008/09 which was triggered by the financial crisis, there are two things to consider:
While each downturn was a short sharp shock, it was followed by a rapid rebound leading to a longer period of positive returns.
At the end of each downturn, the index is still higher than it was at the start of that cycle.
Managing investment risk through diversification
We believe that while investment risk can’t be eliminated, it can be managed. The saying ‘don’t put all your eggs in one basket’ could have been coined especially for investors. Spreading your money across a number of investments might minimise the impact of any single loss, but if all those investments are one type of asset (such as company shares) they could all be affected by the same single event. While this event could cause all share prices to decrease in value, it is highly unlikely that it would cause the value of all assets to fall. This is because each asset class reacts differently to the same political or economic event. We therefore believe that spreading your investments across a range of different asset classes (bonds, property, cash and alternatives) can reduce the chance of losing money in absolute terms because if one type of investment loses money, it is likely to be balanced out by gains elsewhere in the portfolio. Using a multi-asset approach also allows you to flex the amount of risk you want to take in response to changing economic and political events. During periods of uncertainty you can move assets out of higher-risk rated investments (such as equities) and into lower-risk rated ones (such as bonds).
And when the situation changes, you might consider moving them in the other direction.
What are the alternatives?
For some, keeping their money in the bank seems preferable to investing during uncertain times: after all, cash in the bank can’t lose its value.
Or can it?
For whilst your cash might retain its absolute value, its worth is being gradually eroded over time by inflation. Whilst inflation has remained somewhere between 2% and 3% for the past three years, it has exceeded 5% in the recent past (Autumn 2011), and is expected to rise in the near future. Even at 3% inflation, £100,000 would effectively be worth only £97,000 after one year on deposit. That’s a £3,000 loss.
And whilst it is now highly unlikely that a UK high street bank will fail, the Financial Services Compensation Scheme will only guarantee the first £85,000 of your savings (£170,000 if in a joint account).
Another popular alternative is taking the buy-to-let approach to generating income. Whilst headline returns can look attractive, as a landlord you are effectively running a business with overheads, obligations and taxes.
Most obviously, income tax from the rent but also enhanced stamp duty on purchase (currently an additional 3% of the purchase price) and capital gains tax when you decide to dispose of your investment.We will explore inflation and property investing in future Vantage Points.
Investing is not without its risks, but even leaving your money in a deposit account is not risk-free. Very few deposit accounts pay more interest than the rate of inflation. We believe that you are more likely to meet your long-term financial goals if we take a diversified approach and are prepared to invest for a period of ten years or more.
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,
Any views expressed are our in-house views as at the time of publishing.
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In preparing this article we have used third party sources which we believe to be true and accurate as at the date of writing. However, we can give no assurances or warranty regarding the accuracy, currency or applicability of any of the content in relation to specific situations and particular circumstances.
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