The result of the EU referendum in June was clearly not priced into investment markets. As a result, there has been some significant volatility across all major asset classes as investors assimilate the likely impacts of Brexit and valuations adjust to the new reality. Sterling has also fallen to a multi-decade low against the US Dollar.
Whatever your views of the long-term costs & benefits of leaving the EU it seems fairly clear that the uncertainty is likely to remain for some time to come and that there will be a substantial short-term economic effect. So how should you be approaching investment decisions at this point?
Time in the market, not timing the market
At times like these many people are tempted to simply sell their investments and to keep their money safely in the bank. However, although holding cash is the only sensible option for any short-term spending requirements, over the longer run returns on cash have not kept pace with prices so its purchasing power has diminished substantially. The effects may take years to become obvious to you, but it’s a different type of risk all the same; I call it ‘slow motion robbery’.
In contrast, history has consistently shown that stock markets tend to increase in value at a rate well above inflation over the long term, thereby increasing your wealth. Of course, this growth is far from consistent, with falls in the value of shares occurring on a very regular basis.
The prospect of buying low and then selling high, to take advantage of these fluctuations, is therefore highly alluring, yet trying to time buying and selling shares in this way is fraught with difficulty. The market tends to adjust rapidly to incorporate any news and, as a result, investors often miss out on rallies and lock in their losses.
Data from the past 20 years clearly show the power of long-term investing and the dangers of market timing. For example, if you had invested in the FTSE All-Share index at the end of December 1995 your investment would have generated an overall return of 272%. In contrast, if you had traded in and out of the market and, as a result, missed just the 10 best days during the whole period, your return would have been only 102%.
The dangers of ‘home bias’
If the aftermath of the EU referendum on investment markets has highlighted anything, it is the importance of diversification. Many investors – professional and self-directed alike – have a tendency to focus on the familiar: UK shares. It’s worth remembering however that the UK represents just 4% of global output and 7% of the world’s stockmarket value (and the UK has been one of the worst performing of all international markets in recent times).
There are over 40,000 companies listed on global stockmarkets, so this sort of home bias both excludes huge opportunities elsewhere and also exposes investors to localised political and economic risks such as Brexit.
A more diversified investment approach, across different regions and types of investment, as well as within each asset class, is much more likely to deliver consistent returns. For example, over the six months to the end of June 2016 – a period incorporating the immediate aftermath of the EU referendum – Pilot’s portfolios 4, 5 & 6 (our three mid-risk and therefore most commonly-used strategies) delivered returns of +5.9%, +6.9% & +8.2% respectively.
Markets will no doubt continue to be highly volatile in the coming months, but tuning out from the day-to-day newsflow, retaining a long-term perspective and a carefully diversified portfolio are the keys to successful investing post-referendum…just as they were before the vote.