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Ups, downs and riding the waves in between

Record highs and one of the lowest lows – the stock market’s been in the news for very different reasons in the last few weeks.

The market is at an all-time high, prompting headlines and analysis aplenty; while October marked the 30th anniversary of Black Monday, the single largest stock market crash since the Great Depression in 1929.

As an investor or potential investor, one or both topics may be interesting to you – but they shouldn’t affect your strategy.

Lows…

MarketsWhen it comes to market falls, crashes or corrections, you can be certain of one thing: it WILL happen again. But what matters is how detrimental and important will it be to you as an individual?

Investing is all about your future vision. Most advisers talk about a five-year timeframe, but I prefer to talk about a seven-year timeframe. If you need your money within the next seven years, you should be taking a more cautious approach with your investments.

Because when a 1987 Black Monday (or 2000 dotcom, or 2007 financial crash) happens again, you’re going to need time to ride that out. If you don’t think you can stomach such a significant fall in the stock market then you need to reduce your risk exposure by reallocating your assets.

…and highs

With the market at record levels currently, and with a future correction inevitable, you might think, ‘I’m not going to invest yet’. That would be a mistake for your long-term vision.

You can’t ‘time the market’ (try to invest low and/or get out high), because we don’t know when any rise or fall will happen. Say it went up another 20% or 30% from today, and then corrects 10%, and then grows again? You’ve missed out on 20% further growth before riding out the correction, and the markets always rise again after they fall. You might get out in time, but you won’t know when to get back in. Multiple research studies have shown that timing the market loses you money. It just doesn’t work.

A matter of time

Instead, it’s all about your time horizon – how long you expect to be invested. Have you got more than seven years to commit to investing in the stock market? If yes – then just invest, know that markets will rise and fall, and ride it out over the long-term.

If no, you should be thinking carefully about whether you should really be in the stock market at all. If you need access to your money in four years’ time for example, you should be bringing your stock market exposure right down to 20% at most.

The only caveat with this is retirement planning. It used to be that on retiring at 65 we’d crystallise our investments, sell them all and purchase an annuity. Nowadays it’s about adjusting your investment accordingly; as you approach retirement age, typically in your 60s, I recommend you start reducing your stocks right down.

Up to your late 50s, you may have 80% of your portfolio in the stock market; as you reach your 60s and approach 65, you’d reduce that proportion to 60%, 40% and eventually go down to maybe 20% – or even no stock market at all at 65, depending on how risk-averse you are. The rest should be invested in short- or medium-term, high quality bonds/fixed interest, which have very low volatility.

Managing your risk

PLRThe best way to mitigate a market crash is of course through diversification, which takes two forms: spreading your investment in the UK but also the US, Europe, the Far East, emerging markets and so on; and investing in value and small cap companies, which 50+ years of research has shown deliver better returns over time.

While overseas markets won’t avoid all the repercussions when the market does correct here, and vice versa, it’s like ships in a dockyard – they rise and fall together, but by differing amounts at different times. If we have another Black Monday or 2007, it’s likely that all equities will go down, but by different amounts.

And coming back to time horizons in this analogy, the longer we can stay in the dockyard to allow the tide (market) to rise, the deeper the water and the safer our passage out.

But it’s also about how comfortable you are with your risk in the first place.

The stock market, when it falls, typical corrects almost 50% at an extreme. From early November 2007 for example, just before Northern Rock went bust, the stock market fell by almost half in the next year or so.

Consider how you’d feel if you invested £100,000 and it was now worth £50,000 instead? If your time horizon is seven-plus years, then this shouldn’t be a problem, you can wait for the rise; but if it’s 18 months and you wouldn’t be able to sleep, then you’re taking too much risk and you need to dilute your exposure to the market.

I liken your risk exposure to scotch. If you don’t like neat scotch, then how much water do you need to add to make it palatable for you? In the above scenario, if you’re comfortable enough with a 25% drop, then you need to halve your stock market holding and dilute your risk – or pour equal amount water on your whisky.

Whatever your palate’s tastes, keep the above concepts in mind and take the headlines at face value when it comes to your investment.

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