Keeping a cool head and your fingers away from the disinvest button can be difficult when, all around you, financial markets are flashing red. But avoiding knee-jerk reactions is key to maximising your returns when you’re investing.
A key tenet in the world of investing is ‘buy low’ and ‘sell high’. Selling your asset for more than you bought it for means you can pocket the profit. Unfortunately, it’s this well-known City mantra that can lead misinformed investors into thinking timing the market is the best way to maximise their returns.
Uncertainty can come from anywhere, whether it’s the threat of nuclear war, geopolitical strains, or economic turbulence. But what we’ve learnt from the financial markets over the last two years is that markets don’t always react in the way you’d expect them to.
This can leave investors exposed to making costly mistakes if they’re trying to time the market. Imagine your investments slip 10% in temporary two-month volatility, before recovering this 10% and growing a further 10% in the six months after that.
If you had sold early, accepting the 10% loss, you’d have missed out on these returns. This might sound far fetched, but it’s a reality facing many investors, highlighted by a well-known study by JP Morgan.
If you had invested in the S&P 500 in the two decades to 2014 you’d have made nearly 10% a year. Take out the ten tops days of performance and this slips to just over 6%.
Catching a falling knife can be painful, but ignoring the noise and staying focused on your personal goals can be a very difficult thing to do under pressure. Here are four strategies you can adopt to make your money go further.
Invest for the long-term
When you’re investing, there are many reasons why a longer investment horizon can help maximise your returns.
Firstly, the longer you can invest, the longer your money can benefit from being in the market.
You can also afford to take on more risk with your investments. Risk is one of the most misunderstood concepts in the investment world – it isn’t all negative.
Risk and return work in unison, so the more risk you can take with your investments the more you can expect your money to grow – although the further your money can also fall.
If you have a short time horizon and your investments fluctuate, you might not have time for them to recover before you need your money. If you have a longer time-frame, you can ride out any short-term volatility and look to benefit from a recovery.
The longer you can invest, the more you can benefit from one of the most powerful forces of investing, compound interest. Compounding is when the returns you earn on your investments are reinvested and earn their own returns. Over the long-term, this can make a real difference to your money.
Invest in a way for you
Your financial goals, financial background and attitude to risk will be different to your friends and family, and your investments should reflect this.
There’s no point in you having an investment portfolio that’s expected to be volatile if you’re a nervous investor that’s going to check it every day and be tempted to sell when you see losses.
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On the other hand, being too risk averse when you can afford to take on more risk means you could be unnecessarily losing value to inflation or missing out on higher returns.
Understanding your investor profile is one of the first steps in reaching your goals. By understanding what type of investor you are, you can build a portfolio that reflects this.
A risk-averse investor would have a portfolio with a high exposure to bonds, whilst a risk-lover would have a higher equity weighting. Investors tend to fall somewhere in the middle with a mix of asset classes that best compliment them.
Looking the other way during volatility is one thing. Maintaining your investing habits is quite another. Yet, regular investing can actually help maximise your returns, which is why setting up a direct debit can be so useful.
By investing a little and often during uncertainty, you average out the amount you pay for an asset over time.
Imagine this simple scenario: an asset costs £100 on day one, but after two months of extreme volatility falls 10% to £90, before recovering back to £100 a month later. You want to buy three units.
If you had bought three units on day one, you’d have spent £300 on the investment. Had you invested on a monthly basis, you’d have spent £290. By investing regularly, you’d have lowered the amount you would have paid for the asset rather than if you’d invested in a lump sum.
Pound cost averaging works the other way in a growing market, but investors need less convincing to buy when the value of their investments seem to be going only one way – up.
By setting up a direct debit, you can ignore the market speculation and short-term fluctuations that might put you off from investing.
There are simple strategies investors can adopt to manage the risk in their portfolios. One of these is diversification.
By spreading your money across investments, asset classes and geographies, you hope to offset any losses in your portfolio with gains made elsewhere.
Although a simple concept, diversification can be a difficult thing to get right for normal investors, as it takes time and knowledge to master the global markets, as well as an extra cost to trade yourself.
That’s why Exchange Traded Funds (ETFs) are popular with investors trying to get diversification in their portfolios. An ETF is a fund that tracks an underlying index, like the FTSE 100, or investment, like gold.
Essentially, ETFs try to replicate the returns of the investment they are tracking. They are bought and sold just like stocks on the exchange, although they offer far more diversity. Because they aim to replicate the returns of the market and not beat a benchmark, they are lower-cost than traditional funds.
Whilst keeping a calm head when everyone around you is losing theirs is a difficult art to master, these four tips should help you focus on your personal goals the next time uncertainty hits.