Staying the course: Investing in tough times

The first half of 2022 has been a tough period for investors. Rising geopolitical tensions have prompted significant market volatility. After a period of near-uninterrupted growth, markets now need to adjust to a changed climate, where interest rates and inflation are rising and the outlook appears less certain. Investing today may feel like a test of nerve, but there are ways to navigate these difficult times.

It’s worth remembering that markets will always rise and fall, often without much rhyme or reason. Since 1946, there have been 84 declines of 5% to 10% in the S&P 500 – roughly one a year While these feel uncomfortable at the time, the market usually bounces back in a matter of months. These ups and downs are part and parcel of stock market investing and shouldn’t be cause for alarm.

More severe declines happen far less frequently, and markets usually take longer to recover. Since 1946, there have been just three declines of 40% or more. Investors have had to wait a while for markets to recover their previous value, but they have always recovered in the end.

More severe declines are common in individual stocks. Someone investing in Amazon over the past 20 years has made a 1,200% return, but they will also have had to suffer five periods where the stock lost more than 50%. Drawdowns (investor short hand for declines in value) are normal and they don’t necessarily impair your long-term return. The worse thing an Amazon investor could have done would have been to give up during the tough times.

Even if some market ups and downs are ‘normal’, it can still be unsettling. There are ways to balance out the highs and lows. In particular, regular saving is your friend. It means you buy in at a variety of price points, which smooths out your return over time. It also makes it easier when investing in tough times. You don’t have to fret about whether now is the right time to buy or sell, or whether the market is heading higher or lower, you just invest the same every month in all conditions. It’s refreshingly simple.  

It is also worth noting that time in the market is important. Missing the best trading days in markets can significantly dent your return over time. Research by Franklin Templeton shows that missing the top 10 days in markets would have dented your returns by 110% over the 10 years following the Global Financial Crisis. This is because sharp selloffs in markets are often followed by sharp recoveries. If you panic and sell out, you’ll almost certainly miss the bounce. The best example would be the Covid sell-off where markets dropped and then rose very quickly. Investors who had sold out, waiting for the Covid situation to resolve, would have missed the rebound and crystallised their losses. Markets had recovered long before the vaccine was found.

The recent market volatility has thrown up some other anomalies. There was a significant sell-off for many of the world’s largest technology companies – Google, Meta and Netflix. In contrast, there has been a revival for many of the fossil fuel companies, which investors had been avoiding because of their poor environmental credentials. The market mood can change swiftly and when investors are least expecting it.

Trying to find the right moment to switch between sectors is tough. Before the recent rout, technology had looked expensive, but it had looked expensive for some time. The earnings for the major technology companies were still buoyant – it would have been very difficult to predict the turning point.

Maintaining a balanced portfolio – diversified across countries, across sectors and across investment styles – is usually a better approach than throwing everything behind just one corner of the market, particularly if market volatility makes you nervous. That way, there’s a greater chance one part of your portfolio will still be performing well even if another part is doing badly.

When investing in tough times, the temptation is to hide in cash. It feels instinctively safe – you get back the same amount as you put in. You might even get 1-2% in interest each year now that savings rates have risen a little. The problem is that with UK inflation running at 10% in June, the real value of your capital has dropped 8% or thereabouts.

As such, when you’re looking at volatile markets, it is worth remembering that the alternatives may be worse. You can take money out, but where does it go? Savings rates may have risen a little, but not enough to compensate for the rising cost of living to any significant degree. For most long-term investors it’s likely to be far better to stay in the market and find ways to manage the volatility than come out and watch the real value of your capital eroded.

You also need to keep an eye on costs. At a time when investment returns are harder to come by, you need to be careful on how much you’re paying to invest. You need an investment platform with clear costs and no hidden extras. That’s where the Fineco platform can help.