Stay calm and diversify

In tough markets, David Prosser discusses why it could pay to have a diversified portfolio and how investment companies can allow you to achieve this.

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We are already halfway through 2022 and the year is not proving to be a happy one for stock market investors. In the UK, the FTSE 100 index of shares in the country’s largest companies fell almost 5% over the six months to the end of June. US shares did far worse, dropping almost 21% over the same period. Markets in mainland Europe and Asia are also in the red.

How do investors respond to these disappointments? Above all, it would be a mistake to panic. Remember, these are paper losses until you crystallise them by selling your investments. Stock market investment is a long-term pursuit, with ups and downs along the way; running for cover when the latter arrive means missing out on the former.

Bargain hunting

Indeed, there is some comfort to take from this year’s sell-offs, particularly if you’re a regular investor putting money into your investments each month. Lower share prices represent an opportunity to buy more cheaply. At the height of the 2008 stock market downturn, prompted by the global financial crisis, the great US investor Warren Buffett was asked to write a column for the New York Times. He concluded it with this advice: “In short, bad news is an investor's best friend. It lets you buy a slice of America’s future at a marked-down price.”

Nevertheless, the stock market is not a sure thing, even in the long term. We often talk about five years as a minimum holding period for equities, but UK shares, on average, stood at a lower level on 30 June this year than they did five years before. And if you’d invested at the market highs seen at the end of 1999, it would have been more than 13 years before you saw a full recovery.

Strength in diversity

It's a reminder that as well as focusing on the long-term, sensible investors also diversify – they don’t put all their eggs in one basket. Historically, the stock market has delivered stronger longer-term returns than other asset classes over longer periods, but it has always made sense to hold a spread of investments.

Several asset classes offer a good counterpoint to equities, offering the potential for returns that don’t simply run in tandem with the stock market. Commodities are one example – gold, in particular, is often regarded as a good hedge in periods of volatility. Property and infrastructure can also provide the potential for returns that don’t move in lockstep with equities.

Investment companies give you access

Traditionally, however, it has often been difficult for investors to access these asset classes without hiring specialist help or tying money up for long periods. But the good news is that using investment companies, it is now easier to get diversification through these assets than ever before.

Importantly, an investment company is a stock market listed vehicle in its own right – you can buy and sell its shares each day freely. This means that while you might be using an investment company to get exposure to investments that are illiquid or costly, you can get in and out of the fund itself quickly and cheaply, as you see fit.

Investment companies, in other words, are a great way to build diversification into your portfolio. And that can be incredibly valuable. Over the year to the end of June, funds invested in global equities lost, on average, around 27% of their value. By contrast, infrastructure funds rose 4% and commodities funds were up by 14%. Spreading your bets doesn’t guarantee you’ll never lose money, but in volatile times it can pay off.