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CAPITAL HILL ON...
THREE RESPONSES TO VOLATILITYApril 2020
As volatility returns to financial markets, Capital Hill looks at how three different types of investor might respond – from those starting out to those drawing an income in retirement.
March marked the 20th anniversary of the tech bubble bursting. Two decades on and it was a global health crisis that called the bull run to a halt.
“It is far from serendipitous that the milestone anniversary of the dotcom peak falls around the same time as recent market falls,” says Myron Jobson, personal finance campaigner at investment platform, interactive investor.
History shows that markets have a knack of recovering from sharp falls – provided time is on your side. It took 15 years for the tech-focused Nasdaq index in the US to surpass its dotcom peak, which it did in April 2015.
© Fabian Bimmer/AP/Shutterstock.
According to analysis by interactive investor, in the UK, a £1,000 investment in the FTSE All-Share index at the end Feb 2000, just before the dotcom crash, would have fallen to £708 by the end of October 2002. You would still be sitting on a loss at the end of February 2005 with an investment of £984, but by 14 March 2020 would have more than doubled your money to £2,037 – even accounting for the most recent bear market. Had you invested globally in the MSCI All Country World index (ACWI), you would have fared better, turning £1,000 into £2,907.
“While 20 years is a long time, it includes a recovery from both the dotcom crash and the global financial crisis and is an example of the benefits of long-term investing,” says Jobson. “History shows that markets can and do recover from dramatic falls – some of the best years can follow some of the worst.”
Between February and March this year, many equity markets dropped more than 20% – into what is technically bear market territory – in the fastest slide in stock market history, and tumbled further to a near 30% loss as the coronavirus pandemic spread.
“This is a panicky overreaction and will give long-term investors lots of opportunities over the next few months,” says Terence Moll, head of investment strategy at 7IM.
Panicking can lead to poor investment decisions and the standard advice is to keep calm and stay invested. That is easier said than done for someone whose retirement savings are on the line.
Not all investors are created equal – your portfolio should be closely aligned with your personal circumstances and objectives. Capital Hill looks at how three hypothetical investors might respond to volatility.
KYLE, 25, STARTING OUT
Kyle is a junior PR executive living in London. A big chunk of his income goes towards rent for a flat he shares with three friends in the Docklands area of the city. He contributes to his workplace pension but because this comes out of his gross salary, he doesn’t miss it.
His parents are long-term investors and have suggested he gets an ISA. He wants to allocate a small regular amount. He knows financial markets have tumbled and thinks now could be a good entry point.
The monthly minimum investment on investment platforms is typically £25. Kyle plans to invest £50 per month, which he will review as he climbs the career ladder and his salary increases.
Saving regularly could be a good idea, particularly when markets are volatile. A £50 monthly investment in the MSCI ACWI from the end of February 2000 to the end of February 2005 would have grown to £3,121. The lump sum equivalent of £3,000 invested at the beginning of the period would have fallen to £2,425 five years later, an analysis by interactive investor shows.
Looking over 10 years, from February 2000 to February 2010, a period that covers the bursting of the dotcom bubble and the global financial crisis, a £50 monthly investment in global stocks would have generated £8,041. The lump sum equivalent of £6,000 would be worth just £7,019.
“Buying fewer shares when prices are high and more when prices are low smooths out some of the stomach-churning highs and lows in the price of shares,” says Dzmitry Lipski, head of funds research at interactive investor.
TOM, 45, INVESTING FOR THE LONG TERM
Tom is a self-employed managing director of an Edinburgh-based financial services consultancy he founded 10 years ago. He is saving for retirement in a SIPP and he and his wife have ISAs. Their two children, aged six and four, have junior ISAs (JISA).
The investments are held on a platform and Tom can see at a glance how they have performed. Some funds have held up better than others. Diversified funds and those that aim for absolute returns have been able to stem losses, whereas one ‘value’ fund – investing in areas of the market that appear cheap – has fallen more than 50%.
Tom knows investing is a long-term endeavour. He has at least 20 years until he plans to retire, and even then will probably phase it in. His children have at least 12 years before they can access their JISAs.
“When markets are falling, often the best advice is to do nothing at all,” says Sarah Coles, personal finance analyst at Hargreaves Lansdown. “Our experience of markets shows that in the long term everything passes, and if you have a well-diversified portfolio and a long investment horizon, sitting tight is often the best way to ensure your portfolio is best positioned for recovery.”
Tom is sticking with his investments and using available tax breaks. He knows that the ISA allowance is a case of ‘use it or lose it’. He and his wife have invested the full £20,000 for the 2019/20 tax year. Tom took advantage of the market dip and put £10,000 each into two equity funds. One is an investment trust trading at a discount that is wide by historical standards.
The average investment trust discount of 18.4% on 23 March 2020 exceeded where it was at its widest point during the financial crisis – 17.6% on 31 December 2008, according to AIC website data using Morningstar.
Tom’s wife is a little more cautious and has parked her allowance in cash for the time being. “It’s the ISA equivalent of backing away slowly, while talking in a low and soothing voice – and then climbing a tree,” says Coles.
SHEILA, 65, RECENTLY RETIRED
Sheila retired at age 65 earlier this year and her timing could not have been much worse. While drip-feeding into volatile markets, known as ‘pound-cost averaging’, can work in your favour by mitigating the risk of allocating a lump sum at precisely the wrong time, drawing income from a portfolio that has suffered a big drop in value can work against you by turning paper losses into real ones.
An analysis by AJ Bell illustrates the impact of what is dubbed ‘pound-cost ravaging’ for someone entering income drawdown. If you took an annual income of 5%, adjusted for inflation, from a £100,000 pension fund that suffered a 20% drop in value in the first year of retirement but otherwise grew at 4% per year, your pension would run out after 18 years – three years sooner than if you suffered the hit 10 years into retirement. Someone who enjoyed 4% growth throughout retirement could take the same income for 25 years.
Five years ago, Sheila was prudent and moved some of her SIPP into mixed asset funds that invest across different assets classes, geographies and sectors. The diversified nature of her portfolio means it has held up better than the headline stock market slide and is down only 12%.
Sheila hopes to have a long retirement – the average 65-year-old woman will live until 86, according to the Office for National Statistics – so knows she must take a reasonably high level of risk to fund this.
She won’t receive the state pension until she turns 66 early next year, but has started receiving benefits from a final salary scheme. She will top this up with cash savings to avoid taking income or selling capital in her SIPP and give her investments time to recover.
In future, she hopes taking the natural income will be enough. She plans to review her strategy once a year with the help of her financial adviser.
Standardised Past Performance %
FTSE All-Share -3.9 22.0 1.3 6.4 -18.5 MSCI All Country World (ACWI) -0.7 33.0 2.9 11.1 -6.2 Nasdaq 100 8.2 41.1 9.1 22.0 12.5
Performance source: FTSE, MSCI and Nasdaq. Share price total return in sterling.
Past performance is not a guide to future returns.
Changing stock market conditions and currency exchange rates will affect the value of any investments and income from them. You may not get back the amount invested, meaning your capital is at risk.
You should note that tax rates and reliefs may change at any time and their value depends on your circumstances.
This information has been issued and approved by Baillie Gifford & Co Limited and does not in any way constitute investment advice.
Some of the views expressed are not necessarily those of Baillie Gifford. Investment markets and conditions can change rapidly, therefore the views expressed should not be taken as statements of fact nor should reliance be placed on them when making investment decisions.
All figures as at 29 February 2020 unless stated otherwise.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group 2019. FTSE Russell is a trading name of certain of the LSE Group companies. “FTSE®" and “Russell®” are trade marks of the relevant LSE Group companies and are used by any other LSE Group company under license. “TMX®” is a trade mark of TSX, Inc. and used by the LSE Group under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor or endorse the content of this communication.
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AUTHOR: JENNIFER HILL
Jennifer is an award-winning British financial journalist. She left The Sunday Times, where she was deputy Money editor, to set up her own company, mediahill Ltd. She is a previous personal finance correspondent of Reuters, the global news service, and personal finance editor of The Scotsman newspaper. She has won or been shortlisted for six Headlinemoney awards, the ‘Oscars’ of personal finance journalism in the UK. She has also scooped or been nominated for accolades from the Association of Investment Companies, Ignis Asset Management, the Association of British Insurers and the British Insurance Brokers’ Association.
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