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Should you invest in a market downturn?

invest, market, pound cost averaging

Growing your money isn’t always easy, especially when you do it yourself. It can often feel like you need to get your head around the entire financial syllabus before you take your first steps. Even then, how are you meant to know when to invest?

An old City mantra of ‘buy the dips, sell the rally’ encourages investors to invest when prices are low, but is it as easy as it seems?

The concept is quite simple, you buy an investment when the price has fallen and sell once the price has risen, pocketing the profit.

Instinct might have just kicked in; why should you buy something that’s just fallen in value? It’s natural to expect an investment that’s being sold to continue in the same direction, it also takes some nerve putting your money into something that’s been flashing red for a while.

Now take a step back. We know the markets aren’t loyal to one direction; they rise and fall in response to demand, based on the news of the day and global trends. Timing the market can be dangerous, but by increasing exposure to an asset after a decline in its price, investors look to try and benefit from a future rally.

For example, the index of the UK’s largest companies, the FTSE 100, lost 47% after the financial crisis. If investors had bought an exchange traded fund tracking the blue-chip index in 2009, at its bottom, their investment would have grown 108% by now.

The recovery has been far from plain sailing, however, with an end to the commodities super cycle and the initial Brexit fallout causing small sell-offs along the way. Shorter-term investment horizons might have felt a lot more pain.

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As is usually the case, understanding the theory is one thing, implementing it successfully is quite another. After all, you’re trying to time the market, which is nearly impossible to get right when you’re in the moment. Hindsight is a wonderful thing.  

It can also be a challenge identifying the difference between a temporary dip and a wider correction of the investment price – if the fundamentals have changed, the price might never recover. The market can offer fake signs of a recovery after a sell-off, and over-eager investors can become a victim of a dead cat bounce.

Markets fuelled by sentiment

Timing the market requires regular monitoring of global trends and expertise to identify opportunities. Luckily, you don’t have to rely on timing the market to grow your money. There are easier and less time-consuming investment strategies available to balance risk, like pound cost averaging.

This little and often approach averages the price you pay for your total investment over time. By investing regularly, you can ignore market speculation and short-term fluctuations on the market.

Global markets are fuelled by sentiment, and you can never say with any certainty how an investment is going to perform. That’s why diversified portfolios across asset classes and regions can be so successful. If one investment plummets, you can offset these losses with gains made elsewhere in your portfolio.

It also means you are unlikely to be forced to make snap decisions to try and protect the value of your investment in response to market events.

The important thing is to take on a long-term investment horizon to avoid making poorly-timed and potentially costly mistakes. In two or three decades’ time, you probably won’t remember the short-term fluctuations of today.

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