Putting market moves into perspective

By committing to invest, remaining invested and ignoring short-term noise you give yourself a better chance of meeting long-term financial goals.

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  1. Rob Morgan

Financial markets can be volatile, and downs as well as ups are part of investing in stock markets. Tuning out short-term market noise and staying focused on a long-term investment strategy can be hard. But short-term declines should not detract from the potential of the stock market to help meet longer term goals.

Trying to time the markets means investors must get two important decisions right: when to get out and when to get back in. This means there is a risk of having to pay a higher price to reinvest, and missing out on any dividend or other income in the meantime. Markets are unpredictable and allowing emotions to drive investment decisions rarely serves investors well.

Historical market returns show that investors who ignore the sometimes unnerving day-to-day market conditions and focus on the long term are rewarded for their patience and discipline. Indeed they can even take advantage of the volatility through investing regularly. The chart below shows that even with market volatility, an investment in the FTSE All-Share Index 25 years ago would have grown to over five times its original value. The US market has provided even better returns. Over this period returns from a typical UK bank account (Halifax Liquid Gold) have struggled to keep up with inflation (UK Retail Price Index).

Chart: £10,000 invested in the UK and US equity markets, compared with cash and UK inflation, over the past 25 years

Source: FE Analytics 03/01/94 – 03/01/2019, £ total return basis in with net income reinvested; past performance is not a guide to future returns.

Of course, investment choices depend on an investor’s specific circumstances, goals, attitude to risk and time horizon. This will influence how much money can be allocated to riskier assets, and investing is only for those prepared to ride out the ups and downs. All investments involve risk, so the value of your initial investment cannot be guaranteed and past performance is not a guide to future returns.

Conventional wisdom suggests that for terms of less than five years, cash is preferable, since over such short periods, market volatility means there is a greater chance you might get back less than you invest. Investing for a very short period of time, one week or month for example, is akin to gambling. The odds of making or losing money are not much better to that of a toss of a coin. For the average private investor trading in and out of the stock market over the short term can therefore be dangerous – even if political or economic reasons seem compelling. Not only are outcomes unpredictable, but so are their effects on financial markets.

Committing to invest and then remaining invested generally serves investors better. That’s because the effect of compounding the returns you receive over time can be significant. Compounding happens when you reinvest your returns, then reinvest the returns on those returns, and so on. Albert Einstein referred to compound interest as the eighth wonder of the world, and compounding is the engine behind successful long term investing.

The stock market tends to be the most powerful way to benefit from the effects of compounding. When you invest in the stock market you are buying into stakes in businesses. As a shareholder you participate in the growth of a business if it does well and often receive a share of the profits through dividend payments. Sharing in the profits and growth of companies means your capital is potentially exposed to losses, but over long periods of time history shows that investors often benefit from taking these risks.

Leaving money in cash may be the lowest risk approach, but it provides very little return and is unlikely to grow fast enough to keep up with increases in the cost of living; though it does have the important advantage of keeping capital secure. By compounding more volatile stock market returns, and ignoring short-term noise, you give yourself a better chance of meeting long-term financial goals.

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

 

 

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Investment involves risk. You may get back less than invested.