The hot topic at the minute is market volatility – more specifically the fall in stock values. It’s hard to avoid the headlines and if you’re an investor, it can be difficult to be dispassionate about a drop in the market. Our Financial Planners have been taking calls from clients asking whether it’s the right time to move into cash or reduce the level of risk in their portfolio.
Seeing your investments fall in value can be disturbing but making snap decisions as a result could have a negative impact. In the field of behavioural finance this phenomenon is known as ‘myopic loss aversion’. In simple terms this means that people tend to focus on a short term loss of value rather than their long term objectives, which can then cause them to react in a detrimental way.
I hope this article helps to reassure and explain why the recent falls in the market shouldn’t cause too much concern. Here are some key points to consider:
At LIFT-Financial our portfolios are structured so that we invest across different types of holding.
For example, we include commercial property and fixed interest (gilts and corporate bonds) which are sectors of the market that don’t directly follow stock markets.
We also invest in markets from different regions; North America, Europe, Japan, UK, and others. With a diversified portfolio, strength or weakness in one area only contributes to a proportion of your overall investments and so the changes in value you see will be less extreme than the headlines suggest.
Typically, stock markets are valued on the price of the constituent stocks and there is no allowance for dividends. This can give a distorted view of the return and is illustrated by the following example[i].
On 31st January 2014 the FTSE100 stood at 6510.4 and fell to 6242.3 by 31st December 2015, a drop of 4.12%.
However, if dividends had been reinvested then you would actually be up 2.97% over that same period. People investing for the long-term will usually have collective investments which reinvest automatically.
Value vs. Price
It is important to remember that the figure you see for each of your holdings is merely the current price someone is willing to pay for it. If you had 1,000 shares in company X last week, then you still have that same number of shares today. You will only create a loss if you sell the holding for less than you bought it. If in the future the price is higher you will make a profit, irrespective of the journey along the way.
Some people try to time their entry or exit from a market in order to maximise their return. This is incredibly difficult to do. If it was easy, everyone would do it. In the words of Warren Buffet: "The only value of stock forecasters is to make fortune-tellers look good."
The reality is that people are taking a risk by selling now. Missing out on the early days of a recovery can seriously inhibit the growth of your investments in the long term.
Here’s an historical example to illustrate[ii]:
On 3rd March 2009 the FTSE100 closed at 3512.1.
One month later on 3rd April it closed at 4027.9.
Had you invested £1,000 in the L&G UK 100 on the respective days you would now have;
£2,076.91 vs £1,798.65
A difference of £278.26 or 27.8% in terms of the original investment of £1,000.
It is to be expected that markets will rise and fall and there are many short term causes that can affect them. Any rise or fall should always be viewed in context. We’ve enjoyed steady growth in value over recent years but any study of the longer term will show that fluctuation is to be expected.
Investors are compensated for volatility
Market movements can be both positive and negative in the short term but generally those invested in equities will beat cash over the long term. The longer the period of investment, the more this probability increases. Over a period of 18 years, the probability of beating cash increases to 99% [iii].
Nobody can predict the future and the facts and figures above are based on historical events and are not to be relied upon as a guarantee of future returns. That being said, in volatile times, it pays to hold your nerve and view your portfolio in the wider context of it being a long term investment.
Thanks to Richard O'Sullivan, DipPFS for research and content input.
[i] Source: FTSE.com
[ii] Source: FE Analytics
[iii] The Barclays Equity Gilt Study