Hold your nerve as recession looms

The verdict from the Bank of England could hardly have been more depressing: the UK economy is likely already in a recession, it says, and the downturn is now set to last into 2024. That’s bad news for everyone – and anxiety-inducing as you think about where to save and invest for the future.

Here’s an odd thing, however. In the hours following the Bank of England’s latest pronouncement on the economy, which was accompanied by a whacking rise in interest rates, the UK stock market rose. Those gains continued over the course of the subsequent days.

It’s never a good idea to focus too closely on the short-term ups and downs of the stock market. But there is an important lesson for savers and investors in the market reaction to the Bank’s news. The reality is that markets weren’t surprised by the Bank’s assessments; they shared its view. As a result, the bad news was already accounted for in share prices.

Markets and the economy are not the same thing

This is significant. The fact that the UK may be stuck in recession for an extended period doesn’t mean that investments will fall over that time. In turn, that means while your understandable and instinctive reaction to bad economic news might be to steer clear of investment until the picture brightens, that could turn out to be an expensive mistake.

In fact, the AIC has recently published some interesting work on this question. It looked at what happened to money invested in the stock market via investment companies during and after each of the past three recessions to have hit the UK economy. In each case, it found these funds recovered all their losses and delivered positive returns within three years of the beginning of the recession – and that those returns were even higher five and 10 years later.
 

That three-year period is a striking one. Most financial advisers argue that anyone who can’t take at least a five-year view should probably avoid putting their money into the stock market altogether. This is because share prices do tend to be volatile over shorter-term periods, and there’s a danger that if you need to make withdrawals too soon, there won’t be time to make any losses back. In other words, if three years is the horizon you worry about, the stock market isn’t likely to be for you whether there’s a recession or not.
 

Equally, the flipside of that argument is that if you’re prepared to take a longer-term view, a recession shouldn’t put you off the stock market. The experience of the past suggests that patience will still pay off, despite any near-term setbacks. Every recession is different, of course, and the stock market reaction will be different too – but looking back more than a century at UK stock market returns, negative returns over periods of more than five years have been very rare.
 

Protection from funds

Bear in mind too that investment companies give you a diversified way to invest in the stock market. They hold a broad spread of shares, so that you’re not over-exposed to the fortunes of any one company or sector of the economy. Many of them hold overseas shares, which offers further protection, potentially mitigating economic setbacks in the UK.

Moreover, if you’re a regular saver – putting a fixed amount into an investment company each month – there’s another factor to take into account here too. You stand to benefit from the phenomenon known as pound-cost averaging. In months when the value of the fund has fallen, your fixed sum buys more shares in it, helping you recover more quickly when prices rise. The effect is to smooth out volatility over time.
 

The bottom line is that investors need to hold their nerve in the current environment, worrying though the economic news may be. Keep your eyes on your long-term financial goals, rather than getting caught up in the here and now. Investors who did that in previous recessions were rewarded for their patience.