If you have been reading the news in the UK over the past few months you would be forgiven for thinking there were only three events happening in the whole world this year: Brexit, lock-down and the US election.
Finding good companies to invest in can always be a tricky task and although optimism on the end of the pandemic grows, the economic fallout may only just be beginning.
Photo by Micheile Henderson on Unsplash
History doesn’t repeat itself, but it often rhymes
If we assume that in 2021 the global pandemic ends and ‘normality’ returns, what of the economy? One analogy which circulated during the early days of lockdown was that of an induced coma – a temporary shutdown of the economy until we had an all clear. The shared concern was, and still is, can we recover from this?
The best (albeit limited) tool that anybody has for a reasonable outlook into the future is to look into the past – the last three stock market drops 1987 Black Monday, Dotcom crash and the 2008 banking crisis. All events had sustained declines on the FTSE all share for over a year and a realistic recovery time for the economy might be on the order of 5 years.
A major caveat of course is that, unlike in ‘normal’ recessions many parts of the world experienced prolonged periods of lockdowns, layoffs and record debt to GDP ratios.
Form a strategy based on your risk tolerance
Day to day we expect adults to be in reasonable control of their emotions – when it comes to economic movements it is common for many people to violently swing to and fro between immense optimism and bleak pessimism. Forever alternating from manically buying to panic driven selling, with no apparent medium.
During uncertain times people tend to reduce the amount they have invested only to jump back in after the prices meet what they had previously sold them at. This strategy is recommended by no sensible person and yet many sensible people do this exact thing – you are putting undue stress onto yourself with this method and worse still risk guaranteeing losses.
It is far better to form a long term plan that you periodically review rather than reacting on your emotions at that moment, this sounds obvious now, but so many fall into this trap continuously.
Put it this way if you can’t sleep due to stress, feel the urge to constantly check prices or become concerned if there is even one red day on stock prices – you are likely over exposing yourself to risk. Knowing your own temperament can save you a lot of misery in the future - most people would likely benefit from picking a diversified fund and forgetting they have any investments at all.
The lost income years
In almost every sector companies around the world are scraping by from the pandemic hit forcing dividends to be cut, suspended or delayed. This is painful for many investors, not just those relying on income for retirement. Coupled with rock bottom interest rates and low bond yields it is likely you will have to hold a greater amount as a cash buffer as part of your financial plan.
An emergency fund is there for any unexpected situations such as home repairs and being forced to sell off shares and funds at depressed value in order to cover these costs is both demoralising and financially destructive. So as great as the temptation is to put all your income into buying shares, it might be worth holding some in cash or cash equivalents to better defend your portfolio.
Invest in steps to avoid over paying
Investors with a pile of cash burning a hole in their pocket will likely find themselves in one of two camps – patiently waiting for this whole economic uncertainty to blow over and those who see the low as just another prime buying opportunity.
There is a third approach that somewhat combines these two methods by using the understanding of one basic facts – the future is unknowable. It is likely that COVID will leave its mark both in public thinking and the economy for years to come, but despite this even the most pessimistic outlook sees economic recovery in the long term.
So how do you combine patiently waiting in the unknown with a fear of missing out on an opportunity – drip feeding, also known as dollar cost averaging. Instead of investing £300 into a fund at once in desperate hope you have timed everything well, you would deposit £25 per month over the year. Without needing to pay attention to the outside world, you buy more shares when the price is low and fewer when the price rises. This will give you the average return, which historically has even managed to beat many professional stock pickers.
Drip feeding has the added bonus of reducing anxiety – for many people there is a quirk of psychology where a smaller monthly deposit is more appealing than a large (but cumulatively equal) amount leaving their bank at once. Better yet you can have your broker automate this for you so that you don’t need to remember.
This article is not advice and has not been prepared in accordance with legal requirements designed to promote the independence of investment research – no recommendations are given in the buying, selling or holding of any investments. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss. Always seek professional advice.