As part of the financial advice process, your Financial Adviser or Planner will no doubt speak with you about risk assets, such as stocks and shares (equities), forming part of your long-term investment plan. They will also discuss with you the risks associated with these assets and how the risks can be mitigated, depending on your tolerance for volatility (the fluctuations in the value of your investments over time).
Alongside this, they will stress that your investment strategy should be over the longer term (typically over 5 years) and, crucially, the importance of sticking to the agreed plan (unless personal circumstances dictate otherwise). Unfortunately, many private investors, particularly those without an Adviser or Planner, can sometimes react to stock market volatility at the wrong time, which results in losses being realised.
This blog aims to explain how stock markets behave, what drives them, why you should ignore short term volatility and how, by sticking to the plan, your long-term investment objectives can be achieved.
We can look at the long-term nature of the stock market in terms of Bull (rising) and Bear (falling) markets over time. For the vast majority of time, stock market returns are positive, but there are occasions where they are significantly negative. Fortunately, however, these periods of negative returns are relatively short lived i.e., 1.2 years on average, so can be ridden out by sitting still. This is the reason why your investment plan is based over a longer period. Still, the extent of these falls can still be uncomfortable for many people, leading to them selling out at the wrong time, so your Adviser or Planner will look at how the impact of these falls can be reduced.
Source: Vanguard
Notes: Calculations are based on FTSE All Share (GBP TR) and data aggregated from Global Financial Data. A bear (bull) market is defined as a price decrease (increase) of more than 20%. The plotted areas depict the losses / gains ranging from the minimum following a 20% loss to the respective maximum following a 20% appreciation in the underlying index. Time period: 31/12/1945 to 31/12/2022. Calculations based on monthly data. Logarithmic scale on y axis.
Source: Global Financial Data and Bloomberg
Past performance is not a reliable indicator of future results. The value of investments, and the income from them may fall or rise and investors may get back less than they invested.
The chart above is just of the UK stock market and does not include any other types of investment. Your Adviser or Planner will discuss with you the importance of diversifying your portfolio, which means including other, less risky, investments to accompany stock market-based ones. It must be understood that the level of falls that you are able to tolerate will ultimately have a bearing on the level of returns achieved.
Portfolio performance show returns in GBP includes reinvestment of dividends and interest. Excludes platform fees and ongoing adviser charges. Source: Morningstar 31/07/2023
This can be demonstrated by the difference between the returns for three fund manager industry sectors with differing level of equities: up to 85%, up to 60% and up to 35%.
All of them significantly outperform the index representing money market (cash) funds, but to differing degrees. The flipside of this, is that the level of negative return during the Great Financial Crisis (GFC) in 2008/9 (the last sustained Bear market) for the higher risk Equity portfolio is greater than the Cautious.
Portfolio performance show returns in GBP includes reinvestment of dividends and interest. Excludes platform fees and ongoing adviser charges. Source: Morningstar 31/07/2023
Looking at the second chart above, which shows the unlucky investor who managed to invest at the very top of the market in 2007. you can see the difference in the extent of level of falls between the 3 portfolios described above. The lower risk portfolios are quickest to recover their initial value, but they all recover this within around 36 months.
This demonstrates both the importance of agreeing the level of diversification in your portfolio with your adviser in the first instance and sticking with your investment plan over time.
The bear market at the time of writing is different from that of the GFC in that it has been triggered by an unprecedented rise in interest rates in many western economies. This has adversely affected lower risk assets, such as bonds, whose prices are very sensitive to interest rates. This has meant that lower risk portfolios have been affected as much as higher risk ones.
As we appear to be at or near to the peak in interest rates, the forward-looking returns from bonds appear quite attractive. However, higher risk equities are still susceptible to a slowdown in the global economy, resulting from higher interest rates and we may still not yet have seen the lows for this asset class. Therefore, the balance provided by diversification remains important.
So, if it is that simple, why are many private investors driven to sell when the market is in a down phase? The answer is emotions. We are all human and have certain emotional biases hard-wired into our brains.
The chart below shows the emotions experienced during differing parts of the stock market cycle and which are heavily influenced by the mainstream news. They can be useful for survival, but not for investing because they cause us to get greedy during the up phases and panic during the down phases.
Professional investors, however, can behave differently to DIY investors. This is because they are trained in their field, generally have access to better information and, therefore, are better equipped to handle their emotions during the extremes of stock market cycles.
Academic evidence (Kaufman, 2005) shows that, as a consequence of this and as a general rule, professional investors are selling to private investors towards the top of the market and buying from them when they panic at the bottom.
- They will make sure that your portfolio matches your tolerance for risk in the first place.
- As professionals, they generally have access to more information sources than their clients.
- They are able to ignore mainstream media ‘noise’, thus, they are less emotive in relation to investments as a result.
- They can help to prevent clients chasing returns in extreme ‘up’ market, as well as stopping them realising losses at the wrong time during ‘down’ markets i.e., helping them to overcome the fear accompanying market falls.
In summary, professional investors are able to help clients cope psychologically and ‘stick with the plan’. When it comes to assessing the value of your Financial Adviser or Planner, their ability to help you cope with the ups and downs of risk-based investments is one of the most significant contributions to that value.
There is increasing evidence to suggest that, when it comes to assessing the value of your Financial Adviser or Planner, their ability to help you cope with the ups and downs of risk-based investments is one of the most significant contributions to that value (See Vanguard’s ‘Adviser Alpha’, University of Montreal ‘the value of advice’, et al).
The table above shows, in an intuitive way, the performance of different asset classes over 11.5 years.
Diversification is key: It is a high-risk strategy to pin your investment strategy on one or two asset classes in the hope that they might be next year’s winner; they could also be next year’s loser. Holding a range of these assets spreads your risk. However, the proportions will be decided by your attitude to risk. Market capitalisation should not be ignored: the largest market in the world, US large cap (S&P 500), has been in the top half over most periods.
If you are ‘tilting’ your asset allocation, it is important to have a forward-looking view in order to capture the potential returns of those performing assets and reduce the impact of the underperforming ones. Not many asset classes that have performed well in the previous year, do so the next year, so looking back can be perilous (e.g., Asia ex-Japan – top left to bottom right).
Having a bias to your domestic market (so called, home bias) at all times, can lead to allocation to underperforming assets: the UK has been out of the top half more than it has been in it and has often been the bottom performer.
All Rockhold portfolios have diversification and risk management at their core. Using a forward-looking investment process, our investment managers will tilt the portfolios based on their years of experience, whilst maintaining diversification. The intention being to reduce exposure to the assets that are likely to drag on performance in the coming year and increase exposure to those asset classes that are likely to make a positive contribution.
It's important to acknowledge that there's no singular path to growing your wealth and that it depends on your financial goals, your risk appetite, affordability and timeline. Reach out to the Lync Wealth Team today, and let us help you build a strategic financial plan that unleashes the potential of your money #ForYou."
This blog is for your general information purposes only and does not constitute investment advice. It is not an offer to purchase or sell any particular asset and it does not contain all of the information which an investor may require in order to make an investment decision. Please obtain professional advice before entering into any new arrangement. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of its content.