9th February 2023
general
In this guide, we look at the main components of a sound investment strategy and offer tips on how to keep your discipline.
Why Do You Want to Invest?
Before you get started, you should think about why you want to invest. Do you want to secure a comfortable retirement in 30 years? Or have you already built considerable wealth, and want to pursue speculative investments with your surplus capital?
Once you know what you want to achieve, keeping this in mind can help you stick to your plan. This means that when you review your investments, you have a benchmark to measure against.
Risk and Reward
All investments carry a degree of risk. Equities can fluctuate considerably in the short term, but offer the best chance of long-term growth. Cash is stable in the short term, but is likely to lose real value when adjusted for inflation over the years.
In general, the more risk you take, the greater potential for reward. But this needs to be balanced with what you want to achieve.
If you have a long investment timescale and can afford to sustain some ups and downs, you can probably take a significant amount of risk. If you need the money in 5-10 years and don’t have any other assets, a more cautious approach is required. And if you are likely to spend the money in a year or two, holding cash is likely to be the safest option.
It can be tempting to increase your risk level when things are going well, as the potential returns are higher. However, when markets eventually take a dip (and they will), you will be more exposed, and could lose more than you are comfortable with. Similarly, reducing your risk level in a falling market means that when your funds recover, you will not be in a position to fully benefit.
Asset Allocation
Risk is managed through asset allocation. Broadly, a portfolio holding mainly equities and property will be higher risk than a portfolio holding mostly cash and bonds.
But there are considerable variations within each of these asset class. You can invest in the UK or abroad, in small and large companies, and in any number of business sectors. Bonds may be long- or short-dated and the credit rating of the issuer will affect the yield and the potential risk.
Diversifying your investments means that you hold a wide range of assets from across the market. This means that your funds are not too concentrated in any one area.
It’s worth maintaining this diversification, even if one sector is outperforming, or if you have received a tip about a particular share that is expected to do well. We can’t predict how world events will impact any one sector or company, and if things go wrong, you risk losing more.
Can You Time the Market?
When traders buy and sell, the goal is to buy for the lowest possible price and sell at the highest. This sounds simple in theory, but financial markets are too complex for individual investors to achieve this with any consistency.
Firstly, prices can be unpredictable, and determining the high or low point is not possible. We don’t know what will happen tomorrow and prices could always fall or rise more.
Secondly, the theory of timing the market is based on gaining an advantage over other investors. But any information on which the decision is based will already be in the public domain, and therefore priced in. Of course, this doesn’t include insider trading, which is illegal.
While some investors have successfully timed the market, this is down to luck, and is unlikely to be sustainable for the long term.
Avoiding Emotional Investment Decisions
When markets are fluctuating, it can be tempting to allow emotion to drive your investment decisions.
A falling market can be worrying, and many investors opt to withdraw their money. But a dip is usually followed by a recovery, and this can happen very quickly. Taking money out means missing out on this recovery. But more importantly, long-term returns are not based on a straight line. The drop and subsequent recovery are not a short-term anomaly that we need to allow to pass – they are a key feature of how the market functions.
Providing you hold a diversified portfolio at a suitable level of risk, the best way to cope with market volatility is to let it run its course. Avoid checking your investments daily and ignore the financial press, particularly if this is likely to make you more nervous.
Benefits of Disciplined Investing
Holding a wide range of assets for the long-term, and maintaining an appropriate risk level, is the key to a successful investment plan.
Your investments can benefit from compound growth, which is one of the most powerful ways to boost your fund. For example, if your investment grows by 6% per year, over 10 years, this amounts to 60% in simple terms. But if this growth is reinvested, at the end of 10 years, your fund will have grown by 79%. Of course, to benefit from this, you need to keep your discipline and stay invested.
If you are investing regularly, it’s worth keeping up with your contributions, and even increasing them every year if you can. Investing small amounts over a long period can yield higher returns than larger investments made later in life.
Another benefit of regular investing is ‘pound cost averaging.’ This means that your regular contribution will buy into the market at high and low points. When prices are high, your fund value goes up. When prices are low, you can buy more shares for your money, which will boost your fund in the long-term.
A financial adviser can help you keep your discipline and stay on track with your investment plan.
Please don’t hesitate to contact a member of the team to find out more about your investment options.
