Making the most of your investments

It has not been the best start to the year for stock market investors. Falling commodity prices, the slowdown in China, political tensions and the spectre of negative interest rates, have all combined to send global stock markets tumbling. Warnings of doom from a number of market analysts and commentators haven’t helped much either.

So, as pressure mounts on investors to use up their annual Individual Savings Account (ISA) allowance, which in the 2015-16 financial year enables you to shelter up to £15,240 worth of investments from all future income and capital gains tax, should you be sticking to cash?

Not necessarily. For one thing, the people who tend to do best from investing in the stock market are those who recognise that it’s a long-term pursuit: if you can’t afford to take a long-term view – say five years or more – you probably shouldn’t be investing in shares in the first place. If you do have that perspective, why worry about short-term ups and downs? Indeed, those who try to time the market very often come unstuck.

The drip-feed approach

Moreover, there are ways to tread cautiously while still using your ISA allowance to buy long-term stock market exposure. Investment company regular savings plans allow you to invest monthly, rather than all in one go; you can invest as little as £25 a month, but significantly more if you wish (£1,270 a month for 12 months would use up your current ISA allowance).

Investing in this way means you can forget about market timing altogether, as you benefit from a statistical quirk known as pound-cost averaging. In months when markets are down, your fixed investment buys more shares in your chosen investment company. In months when markets are up, you get fewer. The effect, over time, is to smooth out the volatility of the market.

The effect of pound-cost averaging is particularly satisfying during periods when markets are falling. Rather than worrying about the effect on the value of their holdings, investors know that each month their fixed investment is buying more and more shares in the investment company. When markets do return to health, in the long term, they’ll have larger – and therefore more valuable – shareholdings as a result.

Diversification

The other way to cope with market volatility is to ensure your investment portfolio is spread across a broad range of assets, rather than focused too narrowly. It’s possible to diversify through investment companies that hold a broad spread of assets within their portfolios, or by buying a broad spread of more specialist investment companies.

In the case of the former, many of the funds within the Association of Investment Companies’ new ‘Flexible’ sector may be worth considering. These funds all have a mandate to invest in a broad range of assets, but many of them have a specific brief to focus on capital preservation.

Alternatively, funds in the “Global” sector will very often have exposure to the stock markets of many different countries, which will provide some diversification. You can add to that with holdings in investment companies that buy hedge funds, or property, for example.

It’s also worth considering the growing number of investment companies that put money into alternative asset classes including infrastructure, insurance, new forms of finance and debt instruments. Many of these asset classes are ‘negatively correlated’ to the stock market – that is, they tend to perform well at times when shares are struggling.

Finally, it’s worth pointing out that many investment companies have an impressive long-term record of paying rising incomes, thanks to the facility that allows them to hold back excess income in good years in order to fund pay-outs in leaner times. This income can provide important comfort when capital growth is tough to find.