How to deal with stock market stress
David Prosser on to how make investing less risky.
How much further can stock markets go? All around the world, market indices have been breaking through record highs in recent days and weeks. The FTSE 100 Index is closing in on the 10,000 mark and the US’s S&P500 Index isn’t far off 7,000; in Japan, the Nikkei has sailed past 50,000 and kept on climbing. Anyone predicting these gains at the beginning of the year would have been considered wildly optimistic.
In such market conditions, it’s not surprising that growing numbers of analysts are asking how long the good times can last before there’s some sort of correction. But while that might be the obvious question, it’s the wrong one. Rather, the debate should be how best to manage risk while maintaining exposure to assets with the potential to deliver further capital gains.
Regular savings can smooth out stock market volatility.
David Prosser
The old stock market adage that time in the markets is better than timing the market is particularly important here. Trying to second guess stock market tops and bottoms is a fool’s game that often leads to costly mistakes. Investors who build long-term exposure to equities, without getting too excited about the ups and downs along the way, tend to do much better.
In practice, that could mean a couple of things. First, in this sort of market environment, the case for regular savings plans is especially strong. Every investment platform will let you drip-feed money into your favoured investment trusts – via, say, a direct debit for a fixed cash sum that is then automatically invested in the portfolio each month – and it’s an approach that can work really well.
One advantage of regular savings is that it provides discipline. You don’t have to worry about trying to time your investment; rather, your savings just keep on ticking up, month after month.
The second plus point here is that regular savings can smooth out stock market volatility. In months when investment trust prices have fallen back, your fixed monthly sum buys you more shares; as prices recover, this will be to your benefit. Over time, this phenomenon, known as pound-cost averaging, can help you flatten out the market’s ups and downs.
The other practical strategy to explore in these markets is diversification. Exposure to other asset classes – ideally those that don’t move up and down in line with stock markets – will give you important protection.
That doesn’t have to mean shifting chunks of your portfolio into assets considered lower risk, such as bonds or even cash. Rather, consider some of the alternative asset classes that investments trusts provide a route into – infrastructure, real estate and private equity, for example. In many cases, these funds offer compelling long-term capital growth prospects and performance is often uncorrelated to what’s going on in equity markets.
Indeed, one recent study by MSCI found that allocating just 15 per cent of a portfolio to private assets – that is, assets not traded on a public stock exchange – could increase returns by almost 4 percentage points a year without any increase in risk.
All of which is to say that it is perfectly natural to worry about the end of the bull market. However, assuming you’re saving and investing for long-term goals, it’s also important not to let your anxieties push you in the wrong direction. Stay focused on the horizon, embrace regular savings plans and diversify to manage risk.
David Prosser
David is former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine. He writes regularly for the AIC.
