Volatile markets? Five reasons to take heart

Markets recover

It can be difficult to remember in the heat of a market sell-off, but even amid the grimmest times – war, plague, financial crisis – markets recover. Looking at the performance of any major index over the longer-term, these sell-offs appear as little more than short term blips in an otherwise rising tide.

History can be a guide: in 1987, the infamous ‘Black Monday’ crash markets slumped by more than 30%. For those sage investors who held their nerve, a decade later an investment in the FTSE 100 would have been worth around 3x as much. Even those who invested at the peak of the Nasdaq in 2000, which then dropped almost 80%, have now seen their investment double. The crash brought about by the Global Financial Crisis was over more quickly – it took two years to get to the bottom and three years to recover its previous highs.

Admittedly, recovery can take time and it’s difficult to predict when it will turn. Nevertheless, markets have fallen a long way very fast and have absorbed much of the bad economic news. Markets will only fall further from here if the hit to the global economy turns out to be worse than anticipated.

You don’t have to crystallise your losses

Baillie Gifford has suggested that the best approach to a crisis is to ‘worry, rather than panic’. Worrying means ensuring that a portfolio is properly balanced and diversified, panicking means selling everything on the basis that markets will keep falling. By selling, you crystallise your losses and it becomes difficult to make back any money you’ve lost: cash rates are near-zero and any investor holding significant amounts in cash may see inflation erode their savings pot.

In practice, most investors contribute monthly. That means they will have bought in at a variety of prices and they will continue to buy into markets at a lower cost for however long the markets stay low. Through the magic of pound-cost averaging, the impact of these short-term falls in markets is smoothed out over time.

Not all investments are doing badly

The Dotcom boom and bust was exclusively focused on telecoms, media and technology companies. The rest of the market was largely unaffected by the rout. The Global Financial Crisis disproportionately affected the banks. In the Coronavirus pandemic, the hardest hit have been the airline, travel and leisure sectors. The catastrophic falls in these sectors can make the overall fall in markets look worse.

Equally, there are always sectors that benefit. Companies such as Amazon and Zoom have done well during the pandemic and government bonds have proved a ‘safe haven’. In other words, there is always something to invest in and for a carefully balanced portfolio, one element should be working even if the others are tumbling.

The index isn’t necessarily a guide

The scary falls in the FTSE 100 are those that make headlines, but most investors with a well-managed portfolio won’t have taken the full-force of the blow. The FTSE 100 is poorly diversified and contains several ‘at risk’ sectors such as banking and oil. Your stock market exposure will global and should be balanced with government and corporate bond exposure, plus areas such as property.

Equally, the index performance can be deceptive. The FTSE 100 is currently hovering at around 5,750 (to 22nd May), which puts it back on a level not seen since 2012. That suggests investors haven’t made any money over the past eight years. This neglects the effect of dividends, currently running at around 4% a year. An investor with a pot of £100,000 could have gathered over £30,000 in dividends over that time, even more if those dividends had been reinvested.

It will not destroy your retirement plans

These market routs are factored into the long-term performance of stock markets, which in turn are factored into projections in the long-term growth of a pension pot. This may be worrying for those nearing retirement, but good pension planning always builds in some contingency for wobbly markets. Retirement today is very flexible and it is possible to manage round these short-term problems, such as taking income from other sources for a period of time while markets recover.

Stock markets have always been prone to periods of weakness. Long-term returns tend to be higher because investors are being asked to take a risk. These are unsettling times, but the rules of investment have not been rewritten and there will be better times ahead.