Recent market turbulence has just reminded all equity investors that their investments can fall in value as well as rise; in practice, this is probably more a return to the norm, rather than a new phenomenon. Unfortunately, only time will tell!
Everyone needs to remember that there is at least one positive to market turbulence, especially when you are drip feeding money into a stocks and share ISA over a number of years. Not everyone can afford to put the maximum of £20,000 into an ISA in one go, so many people put somewhere between £50 and £1,666.67 in every month and use it to ride the rise and falls of the market.
This gives a bit of jargon that generally mystifies the general public, but can be picked apart quite easily – “Pound Cost Averaging”. When stocks and shares are riding high, you will buy relatively few of them; conversely, when markets fall or falter, your regular payment will buy comparatively more units. At the end of your investment period, when you are “taking stock”, you will see you have more assets than you might otherwise expect.
To see the effect in action, imagine you can invest £6,000 over six months, where the asset prices are 100, 80, 90, 140, 90, 100, over the six months, so the average stock price was 100.
In month one, you bought £1000/100 = 10.00 units
In month two, you bought £1000/80 = 12.50
In month three, you bought £1000/90 = 11.11
In month four, you bought £1000/140 = 7.14
In month five, you bought £1000/90 = 11.11
In month six, you bought £1000/100 = 10.00
For your £6,000 you now own 61.86 units worth £6,186. If you had bought them all on the first day, you would only have £6,000, the same if you bought them at an average price.
Now the warnings; this will only work with investments that are cyclic, if it is not going to bounce back over time, then a loss will be a loss, no matter what. Most commentators suggest that the various investment cycles are somewhere between 5 and 20 years, so putting your emergency cash in a cyclic investment is a really bad idea if you have to cash out during a downturn.
This brings us to the next truism in investment; “diversity is your protection” many assets held in many sectors to spread the risks and, hopefully while one goes bad, another one does well and offsets some or all of the loss. One of the big differences between portfolios designed by advisers and those typically devised by members of the public, is the professionally designed portfolio is usually much broader.
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The information contained is for guidance only and does not constitute financial advice. It is based on our understanding of UK legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change. Accordingly, no responsibility can be assumed by Martin-Redman Partners its officers or employees, for any loss in connection with the content hereof and any such action or inaction.