I’m no investment guru, I do not have a crystal ball and I can’t predict the future.
So, when it comes to investing a key part of the planning process is to align your money towards where you want to be heading; and not to bet on the next hot fund to buy, nor try and speculate in which direction the markets are going to go.
Importantly though, any plan needs to account for the reality that markets go down as well as up. Instead of getting hung up on predicting when the next downturn will occur (which the media do all the time and especially at the moment) it is best to simply accept that it is inevitable at some point and focus on sticking to your plan when it does.
It is important you have an understanding of risk and how you may react in the event of a market crash. Understanding and being comfortable with this is a really important step in the planning process.
By way of an example, let’s say you invest £500,000 into a super diversified investment portfolio with a target allocation of 60% risk assets (global equities) and 40% defensive assets (global fixed interest securities, which confusingly are also known as bonds).
The worst 1 year fall for this type of portfolio over the last 65 years or so would have been around 20%. So, if you were unlucky and had invested just before such a crash your portfolio after 12 months would be worth around £400,000. If this scenario were to play out, it would be best to hold firm and take into account the historical long term upward trend of the markets and to take a long-term perspective, with the expectation that your portfolio will recover. However, investing evokes emotion and this is not always easy to do.
Another 12 months goes by and your portfolio has fallen to £395,000. A fall of 21% since the start date 2 years before. You have experienced two years in a row where returns have been negative. Do you stick with it or run? Your faith that equities will perform better than cash over the longer term, just as they always have, would probably be tested. However, if you can accept that basic framework then no matter how scary it can feel when markets are falling it is just part of the deal of investing.
For the record, the falls noted above occurred in the two-year period up to January 1975. The ten-year return from 1975 onward was 500%. So, for those investors who had held firm their portfolio would have ballooned to around £2.3 million (not adjusted for inflation).
This is an extreme example which won’t happen very often but can be used to illustrate the range of best and worst returns and the importance of taking a long-term view. This in turn can help you to select the right blend of risk and defensive assets which you are comfortable with and which will hopefully meet the needs of your plan.
Part of the dilemma of investing is that no matter how much data we have about the past, we have no data about the future. No matter what history says about the long-term upward trend of the stock market, we still don’t know for sure what the future will bring.
I have no idea how we are going to deal with the massive public debt and all the other doom and gloom the media is throwing at us, but I do believe that we will get through it. To me, investing is based on the weighty evidence of history and seems the most prudent thing to do. So far it has always proven to be correct and so is in our favour. Given this record it is reasonable to assume that your investment portfolio will continue to significantly perform better than cash over the longer term.
On the basis you agree, keep it simple and stick to five principles:
1. Diversify your portfolio.
2. Keep costs low.
3. Establish the right mix of risk and defensive assets and remember there is a correlation between risk and reward.
4. Focus on returns in terms of 5 years plus, and not in days, weeks, months or a couple of years.
5. Be disciplined and stay the course.
So, you don’t need to be an investment guru to have a good chance of experiencing a successful investment journey. Although there will be good and bad times, and abandoning a planned investment strategy can be costly, it is best to hold firm and prior to investing have an understanding as to what could happen to your portfolio in the event of a major crash. Thankfully, they don’t happen too often.