An investor’s portfolio should be built around their specific objectives.
If you are investing for growth, then we normally recommend three main principles...
1) Time in the market
2) Spread the risk
3) Regular reviews
Time in the market – not timing the market
Investors who remain invested over the longer term often achieve better results than those who attempt to time the market.
It is natural to be concerned when markets are volatile and falling. However if you have a suitably long-term plan for your investments and adequate cash reserves to cover your short-term needs, then you should try not to react to every little bit of negative news. If you are worried, seek professional advice before making decisions.
Most investors should therefore plan to be invested for the longer term – five to ten years, or even more. Many investors who attempt to ‘time the market’ often end up disappointed. In some cases they end up significantly worse off.
There are two key reasons why people time the market. Some try to be clever about when they buy and sell to maximise gains. Their aim is to predict when a share will be at its lowest point and then when it is at its highest point. You would need to predict the future (and many events that affect markets cannot be predicted) and you would need to be right twice.
Many other investors make emotional investment decisions. They are influenced by short-term market movements and react to them, when instead they should focus on the longer-term trend and how this fits in with their own investment objectives.
Unfortunately, all too often, this can result in investors entering or exiting the market at precisely the wrong time.
Investor sentiment actually lags market movements so those who react to sentiment often enter and exit the market at the wrong time.
Investors can go though a roller coaster of emotions, starting with optimism, moving on to excitement and then euphoria as markets rise higher and higher, before changing to anxiety as markets fall off their peak and slipping through denial and fear to despondency as markets fall, before improving again through hope and relief back to optimism.
Many investors enter the market or invest more money at the ‘euphoria’ point – but this is actually the riskiest point in a market cycle. Likewise the point of maximum financial opportunity is the time when most investors are despondent and so fewer people are investing at this point.
For example, if you compare movements in the FTSE 100 index with historic net investment flows (investment purchases minus investment sales by retail clients) into equity funds by UK investors since the early 90s, we can see that investment flows significantly increase when markets peak, and conversely decrease during market dips.
However, often the best returns from equity markets come in periods just after a downturn. Markets are very sensitive to economic events and can rebound quickly after good news. Those investors who sold out after markets had fallen usually miss out on the best of the upside and this can have a significant effect on their overall investment performance. Those with capital available to invest who were waiting for markets to improve usually miss out on the opportunity to profit from much, if not all, of the sharp increase in performance.
Often a few very good days account for a large part of the total returns over a market cycle. If you miss these days you could end up with considerably less profit, or even make a loss when you could have made a gain.
As an example, let’s look at a hypothetical investment in the FTSE All Share index over a 10 year period. Investors who invested £10,000 on 1st June 2003 and left it untouched up to 31st May 2013 enjoyed a £14,957 profit. Those who missed only the 5 or 10 best days for performance during the period saw profits drop to £7,163 and £3,626 respectively. Investors who missed the best 20 and 30 days saw losses of £650 and £3,111 respectively.
Next week I will look at spreading the risk and the importance of reviewing your portfolio.
These views are put forward for consideration purposes only as the suitability of any investment is dependent on the investment objectives, time horizon and attitude to risk of the investor.
The value of investments can fall as well as rise as can the income arising from them. Past performance should not be seen as an indication of future performance.
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Written by Gavin Scott, Senior Partner, Blevins Franks