The unprecedented events of recent weeks, including the collapse of Lehman Brothers, the acquisition of Merrill Lynch by Bank of America, the US authorities bailing out AIG, the proposed takeover of Halifax Bank of Scotland (HBOS) and the collapse of the Icelandic banks, has left private investors feeling dazed and confused.
There is no doubt that we are facing an extraordinary and uncertain investment environment, with heavy market falls now a regular occurrence, and many investors are understandably concerned about the impact that further stock market volatility could have on their investments and pensions.
These concerns are particularly intensified for those who have too much of their savings invested in equities, as they will have already endured significant losses. Many private investors had not previously appreciated the risks they were taking in their portfolios, and this has not been helped by an investment industry that has been keen for their clients to buy ever more funds or stocks, such that an equity weighting in excess of 70% has been considered the norm. An investment portfolio predominantly made up of equity unit trusts, or a portfolio of individual shares, has been shown not to provide the diversification that private investors require.
It is not surprising therefore that many investors, fearing further losses, are getting squeezed out of markets, looking for the safer haven of cash and, potentially, planning to return to stocks again when the coast is clear.
However, the likelihood of timing your way in and out of market tops and bottoms is minimal at best. What are the chances that investors increased their equity weightings in the 1990s and then came out of shares just before the market crash at the beginning of the millennium? The former may be possible, but the latter is very unlikely. Contrast this with the sentiment in March 2003 as stock markets bottomed. Very few people increased their equity weightings at this time.
The reality is that some of the best periods often follow sharp falls when most people are put off further investment. From the bottom of the market in March 2003, over the next nine days there was a rise of 18%, this being about 40% of the total rise into the summer of 2004.
History has shown that the most sensible investment decisions are rarely made when they are dictated by either greed, such as buying technology stocks in the late 1990s, or fear.
So, what can one do then? Well, as ever with sensible investing, the answer is “asset allocation”. Even with the reduction in value in most asset classes over the last year, a diversified multi asset class approach will have protected a portfolio’s downside much better than a traditional equity-dominated strategy. By holding a range of different asset classes, such as equities, Government bonds, fixed interest, commercial property and alternative investments, but without too much emphasis on any one asset, then risk can be more effectively managed.
Then, by consistently taking profits in the better performing asset classes and reinvesting into those that have lagged, the investor maintains their target asset allocation position and averages down the relative purchase price of poorly performing assets. Such an approach should weather most storms, and rebound more efficiently from bear markets, inevitable as they are.
So, the best advice for a diversified investor right now would be to sit tight and try to avoid getting frightened out of a sensible investment approach.
A tough investment period, as we are currently witnessing, does not have to be disastrous.
However, experience suggests that, sadly, many investors will get squeezed out of the markets at these levels, while most cash will probably stay where it is, and will then chase the market when it is already substantially higher.
Tom Leonard is a Senior Client Partner at Towry Law