We’ve seen sharp falls in stock markets lately and that has caused many investors to wonder if they should change their strategy. Everyone’s situation is different, so the right answer really depends on you, but we are able to share a few examples that show the kinds of investor behaviour we’ve seen lately.
Note: these three “investors” are based on real people but the names have been changed and the details blurred to preserve anonymity.
1. “This is a once-in-a-generation buying opportunity.” – Bill
After a sharp fall in investment values, the reaction of some people is to withdraw their funds from the market. In other words, they want to cut their losses. Not Bill. He was fortunate to have roughly £200,000 in the bank in February – the proceeds from a property sale – and his impulse, as soon as he saw markets fall, was to invest it all.
Bill’s reasoning is this: he wants to invest that money for the long term. Ideally it will be his retirement fund, and that means he doesn’t mind taking some risk with it. If he suffers negative performance in the next few months, he’ll accept that because he knows the money will be invested in the markets long enough that it will probably have time to recover any losses – several times over, he hopes.
His other reasoning is that now is a great time to, as the adage goes, “buy low”. This is how Bill thinks about it: “Imagine I’ve been eyeing an expensive new item for my house. One day I walk into the hardware store and it’s discounted by 20%. I’ll buy it right away. This is what’s happened to stock markets in recent weeks – they’ve basically put themselves on sale.”
2. “I’m not happy but I’ll keep up my direct debits.” – Rashmi
Rashmi has been investing for several years and, at the start of the year, had accumulated about £20,000 in her stocks and shares ISA. She had chosen a socially responsible portfolio at a risk level 7. Due to the market reactions in the wake of the coronavirus outbreak, she’s seen negative performance of roughly 20% since the start of the year.
Rashmi is understandably concerned by this negative performance. The money in her ISA is basically a “rainy day” fund and although she doesn’t know exactly when she will need it, she is troubled by the idea that she may end up with less than she put in, should she need to withdraw it any time soon.
However, she’s decided to keep up with her monthly direct debit of £500. Her reasoning is that by continuing to invest in regular intervals, she will help to smooth out the effect of market movements. This technique is called pound-cost averaging.
3. “I’ll use my ISA allowance and drip-feed from a cash pot.” – Clarence
Like Bill, Clarence also began the year with a lump sum he wanted to invest. He had roughly £15,000 that he wanted to put into his stocks and shares ISA to add to the £5,000 he had already invested this year. Clarence is keen to invest this extra sum before 5 April so he can use up the full amount of this year’s ISA allowance and ensure he has his full allowance for the next tax year, should he need it.
However, unlike Bill, Clarence doesn’t have a big appetite for risk. He was unsettled by the thought of investing the full £15,000 at a time when financial markets are very volatile. He knew that if he invested that money and suffered negative performance soon after his investment, he would regret his decision.
Clarence has found the perfect solution. He will invest his £15,000 into his stocks and shares ISA but put all that money in a cash pot. This pot is within his ISA wrapper, meaning it is protected from tax, but it will not yet be exposed to the ups and downs of the current markets. Instead, Clarence will arrange to drip-feed the money from his cash pot into the markets at a rate of £1,500 a month¹. This is effectively another way to achieve the smoothing-out effect of pound-cost averaging.
Choosing the right approach for you
These examples show that investors respond differently to periods of volatility depending on each person’s situation, their financial goals and their tolerance for risk. Some investors may be considering withdrawing their funds from the market at this time, or at least lowering their risk level. The problem with this approach is that it may have the effect of crystallising losses, and reducing the amount a portfolio can potentially gain if and when markets rebound.
The examples in this blog show three different ways to respond to the current situation. What’s yours?
- This method of drip-feeding into a Nutmeg portfolio is only available for stocks and shares ISAs and general investment accounts. It is not currently supported for Junior ISAs and Lifetime ISAs.
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance, forecasts and simulated past performance are not reliable indicators of future performance. A stocks and shares ISA may not be right for everyone and tax rules may change in the future. If you are unsure if an ISA is the right choice for you, please seek financial advice.