De-mystifying the spooky world of investing this Halloween.
Don't let your finances give you a fright
The fictional threat of werewolves, ghosts and zombies pales in comparison against, for many, the real-life nightmare of loss of income and unemployment this Halloween in what has been a Covid ravaged year.
For investors, the unprecedented economic uncertainty and the uptick in stock market volatility can be unnerving, and the continued uncertainty over macro events such as Brexit and the US-China trade war adds to the gloom.
However, fear should not keep you out of the stock-market. While past performance is not indicative of future results, history shows that global markets have a knack of recovering from sharp falls over time. And the current level of market volatility offers the opportunity for brave investors to profit from market inefficiencies – where financial assets do not accurately reflect their true value.
If you’re looking to overcome your worries about investing in the current climate and get into the stock market, here are five steps to ensure your investment decisions don’t come back to haunt you.
Step 1: Educate yourself
In a classic case of fear of the unknown, it’s natural for investing to seem scary if you don’t know much about it. We've got lots of tools available with the retail investor in mind. However, if the idea of investing still gives you the chills, there are products available to help.
Index Tracker funds are a low-cost option and can make a solid core for a portfolio by simply replicating the performance of a benchmark index. While these passive investments will not beat the index, the risk of underperforming is greatly reduced. Alternatively, you may prefer to have a fund manager do the work for you; actively managed funds have the potential to outperform trackers but there is also a greater risk of underperforming the index. Investors should be aware that the annual management fee of an active fund will be higher than a passive product.
Step 2: Diversification
Minimise your risk of losses by ensuring your eggs are not all in one basket.
True diversification, alongside a long-term investing horizon, sees risk greatly reduced and is the best defence against the volatile markets we are currently observing. Diversification does not simply mean investing in a large number of companies; ideally, you should have a mix of asset classes such as equities, bonds, cash or commodities. Bonds generally favour low or falling growth cycles while equities favour strong economic growth, so having a “pick n’ mix” approach gives you the opportunity to both protect and grow your pot.
Reducing the correlation between asset classes means that when shares fall, bonds often rise and vice versa, thus reducing your exposure to losses. A combination of different sectors and geographical regions will further spread your risk.
A rainy-day fund is also a useful cash reserve that can be kept for potential disruptions in regular income streams, or for emergency payments when the unexpected happens. Typically, these pots should hold the equivalent of three months’ salary, though if you can afford to save more, you may wish to do so. Access to just-in-case monies helps to take the pressure off when things go wrong and means not having to dig into your longer-term savings.
Step 3: Little and often
Putting large amounts of money on the line can be scary. It’s important to remember that investing a large lump sum on one day can expose you to the higher risk of buying when the market is peaking, so we recommend taking a “little and often” approach to purchasing investments, which can reduce the average price per share paid.
A great idea is to get in the habit of making investing a standard feature of your monthly outgoings via direct debit. How many of us have a monthly gym membership we pay for but never use?! The power of compounding (earning interest on interest) on even a small monthly amount can have a huge impact on your overall portfolio value.
Step 4: Identify your risk profile
Are you someone who enjoys being frightened by a scary movie or would you be more comfortable with something less hair-raising? A risk profile determines how much investment loss you can stand considering things like your investment goals and age.
In the last few months, investors’ risk profiles have been tested to extreme and unprecedented lengths, and the market downfall will have undoubtedly challenged their faith in their own decisions. Of course, during regular trading conditions, investors are rarely faced with such decisions; however, if we can learn anything from the recent period, it’s to ensure portfolios are balanced to withstand sudden shocks in the future.
Therefore, be sure to re-evaluate your risk profile annually, reviewing whether the purpose of your original investment and time horizon is still the same. If your portfolio is not in line with your current situation, you risk being vulnerable to more losses than you are comfortable with. If you are a more cautious investor, you will want to preserve your investment rather than risk losses. A moderate investor will be interested in both capital preservation and growth, and a more aggressive investor will typically have a longer timeline. Risk and reward generally go hand in hand in investing and as a rule, low risk approaches result in lower returns than high risk strategies.
Step 5: Identify your goal
Different goals require different strategies; for example, are you saving for your first house or retirement? Do you wish to simply preserve the value of your investment, generate income, grow your capital, or all three? A clearly identifiable goal will do much to determine the best way of managing your investments.
It is also important to consider your investment timeline. If you are looking to withdraw your cash within less than five years, investing is risky and your money may be best placed in a savings account. The longer your investment timeline, the longer you have to ride out the rises and falls of the market and maximise profits.
Making your first investment is a nerve-wracking experience, but following these steps will make sure you don’t come across any unexpected skeletons in your investment closet. So be brave, do your research and understand your limitations, and your portfolio shouldn’t keep you up at night.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.