When it comes to your money these days, it is hard to know what to do. Interest rates are 0.10% in the UK and 0.0% in the rest of Europe. This has led many people to add more of their money to the stock market, or even invest this way where previously not considered. This has meant taking on risk that they were not comfortable with. Many will have taken the DIY approach, with no adviser to guide them.
Suddenly Covid-19 strikes, and we have travelled back in time to 2015, or at least stock market values have.
Many are feeling anxious and wondering what to do next.
We always spend a great deal of time talking about the “psychology of investing” and how markets work. To do otherwise is akin to buying a car, then ‘maybe’ considering driving lessons and gaining a license to drive, but happily (and dangerously) taking it out for a spin anyway. However, this is exactly what most investors do, since the psychology seems such a flowery topic, yet I would argue more important than any other.
The problem for most individuals, who lose money on the markets, is not the markets at all, but their own worst enemy: themselves!
Human nature is “fight or flight”, thus when something looks bad, we run away from it and when something looks good, we run towards it. The problem is that these instincts work very badly for market investing. The optimal time to enter the markets is when everyone else is selling and values are down. The best time to sell is when everyone is buying, and markets are high.
It is completely normal that the markets correct, often sensationalised as “crashes” with a level of hysteria that causes panic, citing billions or trillions to be wiped off the markets. It is important that long term investors remain calm during such inevitable turmoil.
It is vital that you do not do anything with your investments that causes you to lose sleep at night. Therefore knowing, when markets do correct (as they are now and will do so again), that you have time to wait out such volatility, is key.
The statement “I lost money on the markets today” is either made by someone who failed to diversify (which is simply gambling, not investing) or does not really understand how markets work.
It is important to understand that “volatility” is not at all the same as “capital loss”. A “paper loss” (one where the loss is not realised) is not the same at all as a “real loss” (one where assets have been sold turning the loss into reality). To avoid a “real loss”, one simply must avoid selling when markets are low.
If you own shares in one company and it goes bankrupt, you have total capital loss. If you have 100 companies and a bankruptcy, you have lost 1%, so are experiencing volatility. If you invest in 1,000 companies the volatility is just 0.10%. We tend to suggest around 10,000 and up to 20,000, viewing capital loss as unacceptable, when diversification is the simple solution. Good financial planning is not a roulette wheel!
Making money on the markets is not rocket science. Indeed, if we cut it down to the simplest statement possible “buy cheap – sell expensive”, it seems absurdly obvious, yet this is not what many people do. Greed makes us buy when markets are high and sell when markets are falling.
How does this relate to you, the investor, in the crazy pandemic charged market?
If you have a well-diversified portfolio and a long-term outlook (at least five years, ideally eight or more), this is just a blip, even as the global economy enters recession, defined as two quarters of negative growth (now a certainty, I would argue).
Patience for investors is not just useful, it is the key to success, as is the ability to stay the course. To be a successful investor, you need to be able to accept market volatility, sleep at night and get on with life.
If you are still anxious, then consider carefully, of the money invested in the markets, when you expect to need to use it. If it is over five years (certainly over eight), you can relax. If it is much less than five, then you might draw just enough to cover those years, but no more than you absolutely need and, hopefully, enough to prevent anxiety, whilst minimising any “real” losses. This is a poor fix and the result of a lack of financial planning, however, living a miserable and anxious life is not worth it.
Money and financial health are very important; but we are in a crisis that demands we focus on something much more so; our physical health, and of our families, friends, and neighbours. I do very much hope, however, that this serves to lessen one anxiety you may have. Keep safe and well.
This article was first published in the Connexion May 2020