In my conversations with some clients, I am frequently asked when we will see a large drop in financial markets. It’s typically asked by clients who have patiently been waiting in cash, because they are convinced that when they do invest, the markets will almost immediately sell off significantly. And often those same clients have seen crashes, but considered it too risky to invest “just yet”.
And I can understand these concerns. Bombarded by information about the ongoing uncertainty in life, investors scan daily headlines related to fumbled macroeconomic and company responses to the pandemic. They see the increasing numbers published for inflation and the speculation about whether central banks’ responses will be good enough. And there’s that constant drip of comments highlighting just how expensive equity valuations are, especially in the US, and that prices “have” to collapse soon.
There is good news as well, but it doesn’t sell newspapers and so it’s not visible. It’s the negative that causes us to press pause. It creates a certainty that something must be about to go wrong – perhaps very wrong – and prompts apprehension. These thoughts chime psychologically too – after all, as Daniel Kahneman and Amos Tversky demonstrated in 1992, the fear of loss is deemed to be at least twice as powerful as the exhilaration of an actual gain.
So, given valuations, inflation, the possibility that COVID-19 just doesn’t go away, political tensions, indebtedness (and I can continue) what should you do, particularly if you have been watching the markets, waiting for the ’imminent crash‘? You feel you have to do something given inflation is gradually decreasing the real value of your money and equities are climbing ever higher, but is now really the right time to move?
We cannot predict the future, neither can you, but we can outline your options, which may help give you clarity in these uncertain times:
Let’s examine the pros and cons for each route.
The advantage is:
The disadvantages are:
We would emphasise that, even if there is a correction, statistically most investors remain in cash when this occurs. Fear leads to inaction. It takes some nerve to buy when everyone else is selling. Aside from this, add the difficulty in timing the bottom of a correction. It is human nature to want the best outcome possible, which means people end up missing the boat – even if you sense the fall was due and were ‘primed’, despite being told it’s the best time to invest.
Seen as an interim strategy to an eventual portfolio with a more substantial allocation to equities, this is different to the approach most wealth managers often advocate. Normally, pound cost averaging would be recommended, which sees you dripping funds into the market over time rather than investing all your cash at once. Although the theory sounds plausible, multiple studies have proven that it normally leads to worse outcomes, while only marginally cushioning the ups and downs.
Instead, we would recommend a lower risk option that acts as a stepping stone to your eventual portfolio. This has the following possible advantages:
The disadvantages would be:
Before going into the advantages of this option, it is worth stressing that we consider scenarios which envisage a substantial market crash when advising you. We would never encourage you to invest without examining the impact of a selloff on your financial goals. We call this your capacity for loss. We routinely model crashes for our clients, not only to examine the impact it would have on their wealth goals, but also to prepare for this eventuality. The best trading days in markets often follow the worst ones, so the last thing we would want our clients to do is panic and sell out during a downturn.
The advantages to this approach could be:
The disadvantages might be:
Speak to your private banker. Understand the right options for you. Then make an informed choice.
Markets increase in value 80% of the time, although that’s not in a straight line. Meanwhile, if you plan to wait for that 5% dip, this might occur given it has a 74% probability* – quite good odds. However, that means that a quarter of the time (26%), the dip doesn’t happen. In this case, was it worth it for 5% and forgoing the yield some assets could generate?
It is also worth acknowledging that most investors are waiting for a greater sell off than a paltry 5%, often at least in excess of 20%. The odds if this is what you are waiting for aren’t as great. 20% falls happened only 38% of the time and usually not everything drops in value at the same time. Additionally, we might have profit taken on your behalf, as well as received dividends.
Although, like Chicken Licken, the press runs around shouting that the sky is falling, there are many reasons why markets could continue to rise, which include:
Finally, although I have given you lots of objective reasons why the market might go up or down – there are also behavioural biases to consider: investors want prices to go up, traders want prices to go up, politicians want prices to go up, the Fed wants prices to go up…
Investing necessitates taking risk, which is uncomfortable, but there are ways in which your investment journey can be made smoother as opposed to remaining in cash and accepting the inevitable erosion of your capital.
We regularly publish articles and stage webinars on investments to explain what’s happening in financial markets. And we cover other topics as to how you can manage your wealth. Just submit your email address to receive the updates in your inbox.
Clients of Nedbank Private Wealth can get in touch with their private banker directly to understand how their portfolios are responding to market events, or call +44 (0)1624 645000 to speak to our client services team.
If you would like to find out more about how we manage clients’ investments, please contact us on the same number as above. Or you can get in touch using the links to the forms towards the end of this page.
Sources: Nedbank Private Wealth; and Bloomberg.
* Figures are based on Nedbank Private Wealth’s analysis of daily returns of the MSCI AC World Index Net Dividends Total Return from 1 January 1988 to 27 May 2020.
The value of investments can fall, as well as rise, and you might not get back the original amount invested. Exchange rate changes affect the value of investments. Past performance is not necessarily a guide to future returns. Any individual investment or security mentioned may be included in clients’ portfolios and is referenced for illustrative purposes only, not as a recommendation, not least as it may not be suitable. You should always seek professional advice before making any investment decisions.
Rebecca joined Nedbank Private Wealth in May 2004 having moved to the Isle of Man from Barcelona to pursue a course in Business Studies with the Isle of Man Business School. Rebecca was appointed to the role of investment counsellor in March 2019 to focus exclusively on the company’s discretionary investment management services.
She works closely with our teams of private bankers to provide support in advising our clients with integrity, and to give additional technical investment expertise where more complex portfolio requirements exist.
Rebecca is a Chartered Fellow of the Chartered Institute for Securities & Investment and a Chartered Wealth Manager.
Rebecca joined Nedbank Private Wealth in May 2004 having moved to the Isle of Man from Barcelona to pursue a course in Business Studies with the Isle of Man Business School. Rebecca was appointed to the role of investment counsellor in March 2019 to focus exclusively on the company’s discretionary investment management services.
She works closely with our teams of private bankers to provide support in advising our clients with integrity, and to give additional technical investment expertise where more complex portfolio requirements exist.
Rebecca is a Chartered Fellow of the Chartered Institute for Securities & Investment and a Chartered Wealth Manager.
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Nedbank Private Wealth manages mainly multi-asset portfolios, so our communications don’t tend to focus exclusively on one asset class. However, today we propose discussing equities. Why? Because when you consider the news headlines, and then consider equity markets, we appear to be living in a parallel universe.
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