Investing in unpredictable times

When stock markets are rocky a few strategies can help investors stay on track to reach their long-term goals.

The most predictable element of the stock market is that it will rise and fall. Sometimes the dips are small and the gains are huge, sometimes the drops are painful and recovery is slow.

When the market does drop many investors panic sell, the urge to avoid loss is strong and so is the desire to ‘take action’ when confronted with a problem.

The trouble is that this action often comes after the fall, when the share price has already taken a knock and selling just crystalises the loss and ensures there’s no chance to benefit from a rebound.

It’s a difficult position to be in and can send investors on a quest to find an investment with the potential for gains and no risk of loss. Unfortunately, these don’t exist. There is no investment without risk. To put it bluntly, if you want to end your week with the same amount of money as you started, you need to hold cash. But if you do that, while you might be ensuring you won’t lose money, you’re also ensuring it won’t grow by much either.

There is no way to avoid market volatility and potential loss but there are ways to manage and reduce risk while maximising the potential benefits.

It’s not as exciting or as simple as the mythical ‘no risk investment’ but we believe the best approach is to diversify, focusing on quality and hold your nerve.

Diversification is always a good idea but in times of market volatility it really comes into its own.

Holding just one company’s shares means your whole portfolio will rise if the share’s price goes up. If the business you’ve chosen does well you’ll reap the rewards. The opposite is also the case. If the shares fall in value, your investment portfolio will take a serious blow.

Spreading your money across different areas reduces risk and increases the chance that if a catastrophe does hit, you’ll be invested in businesses that are able to weather the storm.

Take the Covid-19 pandemic as an example. In 2020, stock markets dropped around the world but not all shares fell in value. Some companies including Amazon, Ocado and Peloton profited from lockdown and so did their investors.

It’s possible to diversify your investments beyond shares to include bonds, property, precious metals or other commodities. Making sure your investment portfolio is diverse and has a risk level you’re comfortable with might seem like a daunting task, but it doesn’t need to be. While you can find a range of funds, shares, bonds, investment trusts and ETFs to build your completely bespoke, diversified portfolio you could consider taking a short cut.

Some funds invest in shares and bonds around the world so you can build a diversified portfolio in just one investment. Within these funds investments are spread across a range of assets, countries and companies, which helps smooth returns and hopefully provides a better opportunity for growth.

When the markets are choppy, we often want to dump anything risky and cling to what we know is safe. The trouble with this strategy is that you could easily be selling investments with solid long-term prospects which are a great fit for your long-term goals.

It’s important to remember that no company, region or sector will perform well all the time. A knee-jerk reaction could prove expensive. 

If market turbulence has raised questions about whether you really want to hold a particular share we recommend a review of the quality of your investment. It’s a simple process, quality investing is when you put your money into companies with a consistent track record of strong earnings and stable balance sheets. Buying (and holding) quality shares is a strategy backed by economic theory and real-world data.

Looking over the fundamentals (earnings, profitability and debt) of the companies you hold invest in is a useful exercise at any time. When markets are volatile it’s particularly important to reaffirm why you chose a particular investment and your belief in its prospects over the longer-term. 

Once you’ve determined whether you hold quality investments you can decide on their future in your portfolio. You may find some of your holdings have been knocked by a market event which will have no impact on their long-term prospects and any dips represent buying opportunities.

We’ve never seen a market crash without a subsequent recovery.

Since the turn of the millennium, we’ve experienced the Dot Com Bubble bursting in 2000, the Financial Crisis in 2008, and the Covid crash in 2020. Each time we saw markets drop in double-digits and each time we saw stock markets make a full recovery and then reach record highs.

There’s no guarantee the current market volatility will follow the same path, in fact it’s extremely unlikely markets will act exactly the same way they have before. But we believe that over the long-term keeping your money invested gives you the best chance to grow your wealth and beat inflation.

History supports this idea. Over the last 130 years we can see a clear pattern. Shares outperformed cash 91% of the time over a 10-year performance period.⁽¹⁾

There’s no doubt it’s unpleasant and unnerving to see a splash of red in your portfolio. And, there are no guarantees that the market will bounce back fast. But, history tells us that the stock market has always recovered its losses and the best days in the market are often hot on the heels of the worst days.

Over the short term the market is often chaotic.

There are very few people who can make money on investments when they buy and sell quickly and time the market. Even Warren Buffett (who has had no little success in the area) focused on buying “wonderful” companies at a fair price and holding them for a long time. Trying to time the market and chase the next big thing isn’t impossible but it is extremely difficult and many full-time professional investors fail with this strategy.

While it’s far less exciting, a strategy of holding a diversified portfolio of quality investments over the long-term does have the advantage of reducing risk and a track record of success.

If recent events have prompted a review of your portfolio aim to look for a match to your long-term goals rather hoping to profit from or avoid short-term volatility.