For anyone with investments, pensions, or who is thinking about investing in today’s market, it can be a worrying time. So how does one limit losses, or even thrive, in a market as volatile as the one we are experiencing?
Although we are facing uncertain times with markets constantly shifting, it is still very possible to build up a thriving portfolio. It all comes down to three crucial factors that you must remember:
- Asset allocation
- Risk management
By understanding these three factors, you will begin to be able to not only spot new exciting opportunities in today's market, but also know how to eliminate risk whilst still thriving.
The market in 2020-2021 – what that means for you
From January 2020 to the end of March 2020, the UK stock market had fallen by nearly 35%. It’s a frightening thought and has triggered some people to panic when it comes to their investments and pensions, which is understandable. When stock markets fall, in many cases, people tend to focus on the associated loss and hit the sell button before it gets worse.
But you must remember: History has proven that the market has always recovered.
There is still another 20-25% to go before it returns to where it was in January. Understanding when that return is likely to happen presents a great opportunity for those who have funds to invest.
And this is just in the UK market, one of the poorer performing markets in the world at this time. Take a look at the American market over the last 12 months:
We can see that it is now at the point that it was, back in January. Essentially, the American market has recovered nearly all of its losses.
Here’s another example of a market, the Nikkei market in Japan, that has recovered well:
So how do you diversify, so that your funds don’t fall in the same way the stock market does? The answer lies within the first of the three crucial factors, diversification.
Diversification – why it’s so important
The main thing to know when looking at diversification is that the status of the stock market does NOT have total control over your funds.
At Applewood Independent, our portfolios didn’t fall as much as the market did between 2020 January and March 2020 because we diversified into different asset classes as well as different geographical markets.
We also review each portfolio quarterly and look at the best performing funds in those peer groups. This helps us to protect our clients on the downside and helps them to profit on almost all of the upside.
In some cases, like our biggest risk-taking clients, they have even out-performed the stock market and are now ahead of where they were in January!
This is why diversification is so important. Being able to use the whole global market means we can look at the best-performing markets in the world. We are not just limited to the UK market. The best performing stock markets over the last 12 months have been the US and Japanese markets. This approach, in many cases, has allowed our clients’ portfolios to thrive.
By understanding how diversification works, you will be able to gain a much deeper knowledge of what opportunities are out there.
However, diversification alone isn’t enough. Whether it’s pensions, investments, or both, the most important thing we need to get right in ANY market is asset allocation. Let us take a look at what I mean.
Asset allocation – the most important thing for ANY portfolio
Essentially, asset allocation is ensuring you have the right amount of the portfolio in the right assets, at the right time. It’s a way of making sure that even if you didn’t choose the number one performer in that asset class, your funds will be better off than if you had the peer group in the wrong asset allocation. In other words, picking the right asset allocation with the right peer group is more important than picking the best performing fund in the wrong sector.
Getting this right is pivotal. But when you are dealing in a volatile period like the one we’re in right now, it's also key to review the performance of the portfolio regularly. There needs to be a way to keep bringing the portfolio back into balance to eliminate as much risk as possible.
The best performing funds in ANY investment would usually out-perform the rest of the portfolio over, say, a 5-year period. Then they would start to form a much bigger part of the asset allocation. The worst performers are typically the ones where the asset allocation continues to trend against the best performers and make up far less of the portfolio.
This would logically make sense to anyone. Invest in what you know is performing, right? Not entirely.
Without diversifying and rebalancing the portfolio regularly it can get very top-heavy, for example, all the best performing funds would be in one place. This is a risky business as when the market takes a tumble, you could be set to lose a lot more. Through constantly reviewing and having a process in place to rebalance, you will make sure that your portfolio is always kept in the right allocation.
Now, the amount of rebalancing does vary with each individual. Some are prepared to take far more risk than others and it's vital that you understand your specific situation before doing anything.
Risk management – what risk should you take?
We, at Applewood, have created a list of 18 questions that are designed to give each client a specific risk factor so they know exactly what their level of risk is going forward. Here is an example:
What level would the stock market need to go down by, for you to be worried about your investments?
Questions like this one give us a very clear picture of the risk level of that individual. We then collect this data and give the client a risk level of 3-10 (3 being the lowest). For those with a lower number, we start them off at the lower end of the risk spectrum.
The most important thing is making sure you understand what’s best for you. To put it simply:
- Higher Risk = High reward when the market goes up / bigger loss when it goes down
- Lower Risk = Less reward when the market goes up / less loss when it goes down
But do understand one thing. History has proven that the market has ALWAYS recovered. Back in March, I advised all my clients not to panic about selling investments. Here’s why:
Anyone who sells an investment during a loss will crystallise that loss forever, it's unrecoverable. I always try to avoid this and instead reiterate to my clients (and to anyone reading this) that in many cases when the market goes down, buying opportunities arise.
Some of my clients who have invested at the bottom of the market have now made a 20% return over the last couple of months! There’s always money to be made.
In my experience, the highest performing investors have always been the ones prepared to take the most risk. If you understand that and, of course, have the capital to comfortably back it up, the rewards can be huge.
Of course, it all depends on your situation and it is why I would always encourage speaking with an experienced independent adviser before making any big decisions.
Opportunities in 2020/2021
So what opportunities can you expect in 2020 and 2021?
Well, the good news is that the UK stock market offers very good value for money. Let's look at the FTSE 100 share index over the last 6 months:
- January - 7700 points
- March - 4800 points
- Today (at the time of writing) - 5899 points
Despite the drop in March, it is moving up again and there’s still 25% more upside to be made until we get back to normal. Now, this may take 6, 12, 18, or 24 months but the point is as we mentioned before that history has proven that it’s always recovered. When there is a drop, see it as an opportunity, rather than a reason to hit the eject button.
By managing risk, diversifying, and allocating assets in the right places, you can have more confidence of your funds thriving in a volatile economy.
If you enjoyed this blog and found it useful, you can speak with me further about your investments, feel free to get in touch on 01270626555 or firstname.lastname@example.org.
More to come next week.
The views expressed in this article are those of the author and do not constitute financial advice. Applewood Independent Ltd is authorised and regulated by the Financial Conduct Authority. For financial advice designed for you and your specific circumstances, please contact the author using the contact details provided in this article, or alternatively contact the Applewood Independent Ltd office on 01270 626555.
The value of an investment can go down as well as up. Past performance is not a guide to future performance.