analysis
Balance sheet
Getting the timing of buying and selling
slightly wrong can make a big difference to returns, while
a portfolio including a range of assets can reduce overall
volatility and help to achieve better consistency.
diversification
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THE INVESTOR
|
15
A
t the turn of the century,
technology stocks were
all the rage; but for much
of the following decade
few investors would even
consider buying them after the technology
boom turned to bust. Banks replaced
technology as investors’ favourites in the
Noughties; we all know what happened
to them after the financial crisis. Between
the autumns of 2010 and 2011 the price of
gold rose 40%
1
, but within two years it was
back where it started. Other assets, from
property to commodities, bonds to hedge
funds, have had similar periods when they
have swung in and out of favour.
These fluctuations are also seen in
the fund performance statistics from the
Investment Management Association, with
most sectors having their periods at the
top and the bottom of the league tables
as investor sentiment switches from one
sector to another.
The holy grail of investment is to time
these switches to perfection, buying into
a sector or asset when it is at a low point
and selling out when it reaches the peak.
However, often it’s the opposite that is
the case: it can be difficult to resist buying
at the top just as the hype reaches a peak
and then sell on the way down because the
prices are falling.
Getting the timing wrong can make a
big difference to returns. For example, an
investor with a £100,000 portfolio who
had stayed in the market for the 15 years up
to the end of 2013 would have produced a
cumulative return of more than £216,000,
based on the performance of the UK stock
market as a whole.
But if that investor had missed just 10 of
the best days in the stock market the return
would have been just £118,658; miss 40
of the best days and the return would have
fallen to £40,337
2
.
Academic research supports the theory
that investors are likely to be better off by
ignoring market timing and, instead, taking
a long-term view and adopting a buy-and-
hold strategy.Andrew Clare and Nick
Motson at the Cass Business School looked
at the patterns of buying and selling by
retail investors between 1992 and 2009 and
concluded that those who bought and sold on
market fluctuations lagged behind those who
stayed invested continuously by almost 1.2%
each year.Although 1.2% a year does not
sound like much, compounded it can make a
large difference: over 20 years, the difference
between the two portfolios would be more
than 35%
3
.
Regular‘churn’ from buying and selling
also incurs charges, which can also depress
returns compared to a buy and hold strategy.
Investing across a range of assets –
property, equities, fixed interest, cash and
commodities are among the main options
available – can also help to smooth out
the impact of market fluctuations.This
is because different types of asset react
differently to factors such as economic
conditions, investor confidence and the
global outlook.
In times of great uncertainty, for
example, relatively secure assets, such
as government bonds, are likely to
outperform; when the economic outlook
is improving and confidence is high,
equities and other so-called ‘risk assets’ are
likely to do better.A portfolio that includes
a range of these assets can reduce volatility
and help to achieve more consistent returns
over the long term.
Even within asset classes, individual
investments can behave differently and it is
worth bearing in mind how different types
behave in particular circumstances. For
example,‘growth’-style equities – those
companies in markets that are expanding –
will tend to do well in periods of economic
recovery, when investors are feeling
optimistic about the outlook.‘Value’-style
shares are companies which are under-rated
or out of favour with investors and, so value
investors believe, have long-term recovery
potential. In the bond market, higher-risk
corporate bonds can do better when growth
is strong, while more secure government
bonds are seen as a safe haven against
turbulence. Spreading investments between
these different styles within an asset class
reduces the need to second-guess what
economic conditions we will be facing over
the medium term.
Of course, buy and hold does not mean
buy and forget.You need to ensure that the
portfolio still meets long-term investment
goals.Among the areas to discuss with
your adviser are: How have the goals of
investment changed? Are there more new
opportunities available to invest in?Will
access to your savings be needed quickly?
Investment goals can change over time
– someone starting out in their career may
need a strategy that prioritises long-term
growth, for example, while someone who
has retired may want to focus more on the
income generation of the assets.The review
should also consider the balance of types of
assets and styles, how they have performed
and whether there have been any changes of
managers or style.
Regular investing is another way of
reducing the impact of volatility on portfolios.
Drip-feeding your money into the market
gives the potential to buy more units when
share prices are falling so, when prices
recover, investors will have more units
with a higher value.
The key factor to remember is that
investment should be a long-term process.
Instead of worrying about short-term
market noise, it is important to think about
the ultimate goals and to build a diversified
portfolio, including a range of assets to help
achieve these goals.
1
2 Financial ExpressAnalytics
3
A portfolio that
includes a range of
these assets can
reduce volatility
