A Short Guide to Brexit and How to Cope With Market Volatility
With the Brexit deadline looming, at the time of writing we are still no closer to a deal. Investors are understandably concerned about the impact of Brexit, particularly if no deal is reached.
There is enough negativity and scaremongering in the press. We can’t control the outcome of Brexit or even speculate on what a final deal may look like. Understanding what we can’t control and building in contingencies is part of financial planning.
In this guide, we look at how your investments interact with your financial plan, and why you probably shouldn’t worry too much.
Diversification is Key
The market may experience some short-term volatility as the Brexit plan plays out. This is one of the factors we can’t control. However, a strong investment portfolio invests across the globe in different industries and sectors. Some of these may thrive in the event of Brexit. Some companies may struggle and ultimately go out of business. Others may not be affected at all.
The idea behind diversification is that you should invest in multiple assets that are not correlated with each other. In simple terms, equities and bonds often move in opposite directions depending on the economic situation at the time. This means that if share prices fall, the fixed interest element of the portfolio should provide a baseline of security and compensate for some of the losses.
In an investment portfolio, the strategy is a little more complex, but works on the same principle. Your portfolio may invest in hundreds of different companies (either directly or through funds), all of which may be affected differently.
A diverse portfolio is well positioned to absorb the worst of any volatility.
Markets are Not Always Predictable
After the Brexit vote in 2016, many investment portfolios thrived despite the uncertainty. While this was a positive development for many investors, it was partly due to the pound’s fall in value. This meant that overseas assets were valued higher, simply due to foreign currencies being worth more relative to Sterling.
Returns were further boosted, as UK companies trading overseas benefited from a weak pound.
There are gains and losses in every major political or economic shift. Even inherently negative events (such as a drop in the value of the pound) can have some benefits.
Markets are Efficient
There may be some tactical advantage to be gained by skilled investment managers, particularly in the more specialist asset sectors. However, investing all of your money in these areas is incredibly risky as they do not always get it right.
A typical, well-diversified investment portfolio may have some holdings in these funds. They will receive modest benefits from the gains, but be protected from large losses.
At the portfolio level, investors don’t really benefit from tactical decisions or attempts to time the market. It may seem like a good idea to sell your investments or switch funds, but chances are that several thousand other investors have also had the same idea.
Information is so readily available today, that any data that may influence your decision to buy, sell or hold is already priced into the market.
This means that any decision taken now, with the aim of benefiting (or at least not losing money) from Brexit, is likely to be detrimental in the long term.
There were times between 2008 and 2010 that it seemed like the world was ending. Funds, companies, banks and economies collapsed. Investors lost millions, and years of austerity followed, with many people still feeling the impact.
When we look at fund performance charts ten years on, this devastation is reflected as a small blip in an otherwise upwards trajectory. Most investors are vastly better off having had faith in their investment strategy and not panicking.
A feature of an efficient market is that it is impossible to know when to buy and sell. An investor could, in theory, sell their assets at the high point just before the crash, before reinvesting at the lowest point to benefit from the low prices and subsequent recovery. The problem is that no one actually knows when the high and low point will occur.
For most investors, it is far more beneficial to trust the markets than to try and make these decisions.
Your Risk Capacity
Of course, there may be some losses in the short term, and some investors simply cannot cope with that. Personal tolerance and capacity for risk is a key discussion point at our meetings with clients.
Keeping calm and staying the course is the best advice for most clients.
But for others, the idea of losing even a small amount in the short term is a worry. The idea of long term returns and keeping pace with inflation does not really help when someone has just retired, as early losses could throw their plans off-track.
This is why we take the time to get to know our clients and understand their worries as well as their financial situation.
Your Long Term Plan
Investment decisions should be taken as part of a wider financial plan, rather than in isolation.
A young investor with high earning potential can afford to take significantly more risk than a retired person living on their pension. There are numerous other factors to take into account, and every client is unique.
Part of financial planning involves planning for the worst. For example, keeping an easily accessible cash reserve means that you can cope with any emergencies and will not need early access to your investments. Any investment withdrawals should be planned in advance as far as possible.
When we create a financial plan, we do not aim to avoid difficult events as this would be impossible. Instead, we plan for the risks, and ensure that even if the worst happens that you can still achieve your goals.
Please do not hesitate to contact a member of the team if you would like to find out more about our investment proposition and how we manage volatility.