Keeping your cool among bears and bulls

Investors around the world have enjoyed a remarkable run over the past 18 months, with major stock markets and headline indices soaring without relent. The Dow Jones worked its way up from the 20,000 mark a year ago to an impressive 26,616 last week. The Nikkei 225’s sharpest gains have come in the past six months, rising from around 19,500 to 24,124 at the end of January. The DAX Performance-Index shot up from under 12,000 to almost 13,600 in a similar timeframe.

On our shores, UK stocks and shares have done well to a slightly lesser extent, although the FTSE 100 has flown along from 6,021 at the time of the EU referendum to record highs of 7,778 when trading closed on 12 January 2018.

Such a sustained head of steam left experts convinced that a correction was overdue. But few could have anticipated the shock that was to come this week, as roughly $4 trillion was wiped off the value of global stock markets on Monday. At one point, the Dow dropped more than 500 points, the Nikkei fell nearly 7 per cent, and the Footsie had plummeted to 7,079 after a sixth straight day of losses – reversing 12 months’ worth of gains in the process.

The tide has since been stemmed somewhat with shares bouncing back, and overall losses now estimated to have reduced to under $3 trillion at the time of writing. However, after more than a year of uninterrupted bliss, it represents a stark reminder to investors and pensioners of the volatility and risks involved with having portfolios which are greatly exposed to dips in stock market performance.

Keeping yourself protected

The falls in US markets have been attributed to reports of a surprise uptick in US wage growth at the end of last week (and an anticipated interest rate rise as a result), with computer-driven trading blamed for both exacerbating sell-offs and spreading investor panic. But while that may leave some inclined to think the downward trend will soon right itself, many others believe there is further to fall for equities, given the previous extended bull period.

It thus becomes important to protect yourself, and there are a few basic principles which can help. The first is that stock market volatility is an historical given, and such peaks and troughs are part of the investment lifecycle. However, markets do invariably grow over time, so it pays to plan for the long-term, rather than trying to constantly fiddle things in a bid to pre-empt highs and lows.

It is, nevertheless, still a good time to take a breath, review your own individual situation, assess your attitude to risk, and consider whether your portfolio is sufficiently diversified.

Risk, diversification and other asset classes

Your level of risk tolerance is entirely personal and subjective. But age is often a key determinant. If you are early in your career, and have many years of saving ahead of you, it is entirely justifiable to take on a bit more risk when structuring your investments, as volatility is easier to stomach. However, if your retirement years are approaching, or indeed if you are a pensioner, it may be worth shifting a higher percentage of your portfolio away from equities towards safer, lower-yield alternatives.

Diversification plays a key role in ensuring the likelihood of your portfolio producing consistent gains over time. And according to Holly MacKay, CEO of Boring Money, a good rule of thumb is to comprise a typical portfolio of between 12 to 15 funds, spread across multiple asset classes. 

The traditional safety counter-weight to stocks and shares has been bonds (or even cash), but the advent of asset classes such as peer-to-peer lending has shaken up some old norms, offering a midpoint in terms of risk and reward. And in more than a decade of existence, it has delivered steady, predictable returns to investors - at least from reputable, regulated platforms anyway.

Unlike stocks and shares, the value of the investment does not go up or down, and the investor is instead locked into an agreed rate of return at the time their money is lent to a borrower. The only caveat is that returns are not guaranteed, and your capital is not covered by the FSCS - albeit that platforms generally have measures in place to counter these risks.

Other emerging investment opportunities include cryptocurrencies such as Bitcoin, albeit that these are fundamentally different, and recent performance has arguably brought new meaning to the word 'volatile'. Although there is good reason to believe that the technology behind cryptocurrencies - namely, blockchain - will continue to be one of the cornerstones of fintech in years to come, putting your hard-earned money into such investments should not be done without serious consideration beforehand.

New order, same rules

Rising new asset classes and almost-freakish stock market performance bring us to an interesting juncture. Not unprecedented, but certainly unusual. Stock market corrections are loosely expected at least once a year, so the bull run we’ve witnessed over the past 18 months can cloud judgment, and subconsciously recalibrate norms in the mind of an investor.

But the same principles of investment still apply. What goes up, must come down - if not in equal measure, then certainly with a tempering effect.

At the same time, if things were to continue to slip towards bear territory in the weeks and months to come, keep your head. Panicking will be of no help whatsoever. 

Instead, take stock of your investments, and plan for different scenarios which could happen: don't simply expect what is happening at present to continue forever. This may involve reassessing the setup of your portfolio, adjusting overall risk, and/or putting increased thought into incorporating other asset classes.

Knee-jerk reactions are not the name of the game. Yet neither is unfettered inertia, and periodic reflection and review is advisable. However, if you stick to the investment principles which have stood the test of time, and make clear-minded decisions, then you will almost certainly emerge as a winner in the long run.

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Our website offers information about saving, investing, tax and other financial matters, but not personal advice. If you're not sure whether peer-to-peer lending is right for you, please seek independent financial advice, and if you decide to invest with Lending Works, please read our Key Lender Information PDF first.

As with all investments, your capital is at risk.