What is your investment plan, and should you be worried by market turmoil? For many investors, these two modest questions will probably prompt extreme anxiety. It’s entirely reasonable to be worried by stock market volatility. But many investors are also strangely reluctant to spell out their investment strategy, beyond obvious truisms such as “produce long-term profits with the least amount of risk”. So here are six tips on how to build a plan that will be resilient even when times get tough.
If you go to a financial advisor, then they will discuss your attitude to risk in several different ways. But nearly every approach will probably start with a simple insight – how long is your time horizon? Or put more bluntly, when do you need the money? If you can wait for more than five years, and preferably 10, then a conversation about the risks and opportunities in equities can start. But if your time horizon is shorter than that, then maybe risky investments such as equities are not the right choice for you. It might make more sense to work out where you can save more money, and then consider less risky options such as savings accounts or government bonds. So that’s tip number one: when you invest in a risky asset such as a share, ask if you can afford to wait for a minimum of five years (and preferably more) before accessing the investment. If you can’t, then don’t invest in equities. Simple.
Second, if you can answer “yes” to taking some long-term risk, then consider splitting your investment portfolio into two buckets. The first is your “core” portfolio; the second your “satellite” portfolio. The core portfolio is your “leave alone” capital, where the aim is to keep it simple, lower-risk and imbued with “common sense” (more on that in a moment). The satellite portfolio is where you can experiment with more adventurous ideas.
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Use your common sense
That brings us to the third tip: to practise “investment common sense” in your core portfolio. In essence, this boils down to a set of simple, tried-and-tested investment habits. Diversify between asset classes, risks and countries. Keep your costs to a minimum – one of the few certainties in investment is that excessive costs will destroy your long-term capital. Lastly, rebalance your portfolio at least once a year. The academic consensus on this is not clearcut – but a common sense approach is that once you’ve decided on your mix of investments, review the resulting portfolio every year, and if one or a number of investments have shot up in value, consider taking some profits, then reinvesting the cash you get back into your original portfolio mix, which means investing more money in the ideas that didn’t quite work out that year.
Fourth, for the core portfolio, it probably makes sense to invest using funds. Picking individual stocks can be fun, but it can also be inordinately risky. Say you decide that for the long term you want to have exposure to gold as a hedge against higher inflation or incompetent central bankers – a perfectly sensible idea. You opt to invest in a gold miner, largely because it’s an actual business, produces real profits and dividends, and is hopefully growing year on year. So you think: “That’s it – I’ve got a portion of my portfolio covered. I’m hedged against uncertainty about inflation.”
The danger is that individual businesses present what are called “idiosyncratic” risks. What happens if said gold miner is badly run, or a new mine fails to produce the projected profits? In short, you might be right to pick gold mining equities overall, but you may have picked the wrong individual miner! A fund approach tries to minimise this risk. The fund will, hopefully, contain a mix of different gold miners, minimising the idiosyncratic risk. Remember that stock picking is a risky business – if you really must indulge, then do it in your satellite portfolio where you can have more “fun”!
Cut your losses early
Point five: think creatively in that satellite portfolio. This is the pot of capital where you are willing to take more risks. Trying to time markets is an incredibly difficult exercise and probably best avoided – but if you must do it, view market turbulence and volatility as an opportunity, not a risk. If you think you have found a brilliant long-term idea, buy more of it when its share price is down and then sit tight! But also apply a ruthless discipline. Be ready to cut your losses if your brilliant bet is wrong. Talk to many of the most successful investors and they’ll tell you that they spend as much time thinking about when they are going to sell an investment as they spend researching why they bought it in the first place.
Which prompts one last related insight. You learn from your investment mistakes – so never be afraid to admit you’ve made one. Cut your losses, learn the lesson – and then move on.
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