Stock markets have been flying high for months on end, so arguably a correction was inevitable. Over the last few days, global stocks have suffered some of their worst falls since the financial crisis. In total, nearly £2.8 trillion has been wiped off global stock markets. The sell-off was sparked last week by strong jobs and wage growth in the US, suggesting that inflation might follow suit — and interest rate rises will come next.
Time v timing
However, it’s important for investors to remember that investments are for the long term, so short-term volatility is not necessarily a reason to panic and make drastic changes. When shares are falling, any loss or gain is only realised when you sell your holdings. Volatility is the price you pay for the long-term outperformance of equities over other asset classes.
Corrections often provide investors with an opportunity to add to their portfolios at attractive prices. Looking back at the history of market corrections, the majority turn out to be short-term wobbles. In fact, some of the worst historical short-term stock-market losses were followed by big rebounds.
The smart strategy is to stay fully invested through market cycles. As the old stock market adage goes — time in the market matters more than timing the market. A correction can actually work to your advantage if you invest a monthly amount, thereby investing at different market levels, and buying cheaper shares if prices continue to tumble.
By drip-feeding your money into the market you can smooth out the highs and lows in share prices because when they go up, the value of stocks rise, and when they go down your next contribution buys more. This is known as ‘pound-cost averaging’.
Diversification
Market shocks also highlight the importance of diversification. Diversification across different markets and asset classes will enable your savings to adapt to different markets, and crucially, reduce exposure to one individual area. But don’t make the mistake of buying too many funds as you’re likely to have lots of overlap, which will defeat the point of buying more to spread the risk.
If you don’t have the stomach for volatility within your equity holdings, you may want to look at protecting the wealth you have grown by using funds designed to preserve capital. You can also limit volatility using a multi-asset income fund which invests in a range of assets. They can help capture the growth of various asset classes at a risk level to suit you, as managers can dip in and out of a wide range of markets on your behalf.
The group most at risk from market shocks are those who are drawing from their pension. Anyone who is selling their investments to fund pension income should watch closely to ensure they can afford to continue to take these payments. If the falls continue, it may be wise to reduce withdrawals — if you can afford it — to ensure your pension lasts as long you need it to. People who are taking only the income that is naturally produced by their pension investments will be largely unaffected by any share price falls.
