In troubled times, the attraction of tinkering with your investment portfolio increases. This blog explains why doing the opposite will give you the best outcome.
What do you do when the investment markets appear volatile and the economic future is uncertain?
This is a perennial question for many investors, and this blog explains why for most, it is a case of:
“Don’t just do something, stand there.”
Here are a few principles to consider for investing in general. By following them, you should weather any storm. Don’t tinker or meddle with a well-planned portfolio. This will leave you at the mercy of unintended consequences. There is a popular saying that goes, “There is no such thing as bad weather, only inappropriate clothing.” Wise words when it comes to investing.
Some investors are tempted to fiddle with their portfolio’s structure to try and ready it for potential short-term global events, such as Brexit. You would do well to remind yourself that the core tenets of good investing hold true through all market conditions.
The effectiveness of a portfolio’s strategy isn’t judged on the post-event outcome, but rather in terms of the quality, validity, and prudence of its discipline in the face of future market uncertainty. Portfolios are structured around absolute investment truths, especially the value of deep diversification.
Regardless of what might happen in the future, including any potential permutations of Brexit, you can rely on a number of truths as an investor:
• Markets work pretty well and are hard to beat, so capturing the market return on offer using lower-cost, well-structured products makes good sense;
• Spreading your assets to ensure the risks you face are well-diversified will sit at the core of a successful long-term strategy;
• Balancing out the risks of equities by owning high-quality bonds provides a good insurance policy;
• Being patient (living through the short-term dips) and disciplined (maintaining your philosophy and strategy over time) is fundamental to achieving the returns you need to fulfil your financial goals.
At this point, in the context of short-term uncertainty and anxiety regarding Brexit, let’s focus on diversification.
There are many ways in which your investment portfolio can be diversified, from individual securities to sectors, countries, investment styles, and assets classes.
Owning a portfolio that includes many thousands of companies, within all market sectors and spread across developed and emerging economies, reduces the risk of being caught out by material negative effects in specific markets, such as the UK.
The UK market is dominated by a few big companies: the top 10 stocks represent more than 35% of the total UK market and the largest, HSBC, accounts for 5.3% of the broad UK market.
A market-capitalisation weight to stocks across all developed and emerging markets shows a very different, well-diversified picture. The largest listed company in the world is Microsoft, at 2.2% of the market. It is worth noting that Microsoft’s market capitalisation is over US$1 trillion, compared to HSBC’s US$150 billion.
In a global market capitalisation weighted portfolio, HSBC’s weighting is reduced to under 0.5%. Therefore, an astute investor will hold material allocations to non-UK company shares and the majority of companies this represents.
Sector diversification also makes good sense. Owning a material allocation to global shares ensures that sector exposures are diversified. The UK has some large sector allocation differences compared to the world as a whole.
It has no major technology companies like Microsoft, Amazon, and Google, despite technology stocks representing around 15% of global equity markets. The UK exposure to technology stocks is lower than 3%, while it is overweight to the energy and basic material sectors.
Brexit and the political scenario that we see before us, combined with the polarisation of politics, is unsettling for us all. We are where we are, regardless of one’s views on Brexit or political persuasion.
All client portfolios have commonalities that can be relied upon, including broad diversification, expertly managed, lower-cost investments, and high-quality bonds. If it isn’t broken, don't fix it. Portfolios are as well-positioned as they can be for what lies ahead. Don’t worry too much about your portfolio. It is in good shape.
Volatility vs Risk
It is important to understand the difference between volatility and risk before deciding on an investing method. Volatility in the financial markets refers to extreme and rapid price swings. Risk is the possibility of losing some or all of an investment.
As volatility of the market increases, so do profit potential and the risk of loss. In the non-Capital 'active' investing world, there is a marked increase in the frequency of trades during these periods and a corresponding decrease in the amount of time that positions are held. In addition, hypersensitivity to news is often reflected in market prices during times of extreme volatility.
Avoid the noise.
Take a look at this video to learn more about volatility and risk:
If you feel that you are in need of a calm and rational voice, don't hesitate to contact one of the team at Capital.
Other notes and risk warnings
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