When markets rise its human nature to want to invest more. Missing out on strong performance is a powerful emotional pull. When markets fall fear takes over. Instinct tells us to sit on the side lines, or to sell investments to avoid losing more money. In theory, though, we should be doing the opposite: using times of weakness to buy or top up investments at lower prices.
Putting market moves into perspective
With the current bull market in shares nearly a decade old, investors are naturally wary of how much longer it can last. Yet we would caution against trying to time investments. It is very difficult to get it right as even if you sell at the peak you have to make a judgement about when to buy back in. In addition, being out of the market means the flow of any income from investments such as dividends could be interrupted.
As the chart of returns from the FTSE All Share Index below shows, there have been many peaks and troughs when investing in the stock market, but investors are generally rewarded over the longer term.
Chart: £10,000 invested in the UK and US markets over the past 25 years
Past performance is not a guide to future returns.
An investment in the FTSE All-Share Index 25 years ago would have grown to over six times its original value on a total return basis with net income reinvested. The US market has provided even better returns. Over this period returns from a typical UK bank account (Halifax Liquid Gold) have struggled to keep up with inflation (UK Retail Price Index).
There are also reasons to be optimistic markets can recover from the recent dip and provide decent performance – as Charles Stanley Chief Investment Officer, Jon Cunliffe, points out here.
Of course, investment choices depend on an investors specific circumstances, goals, attitude to risk and time horizon. This will influence how much money can be allocated to riskier assets, and investing is only for those prepared to ride out the ups and downs. All investments involve risk, so the value of your initial investment can go down as well as up, especially over shorter periods.
Stick to the plan
Committing to invest and then remaining invested generally serves investors better. Thats because compounding (the effect of earning returns on your returns) can be exceptionally powerful over time. The key is to start as soon as you can and to stick with it as long as possible. The longer your money is invested, the more potential there is for growth.
The stock market tends to be the most powerful way to benefit from the effects of compounding. When you invest in the stock market you are buying into stakes in businesses. As a shareholder you participate in the growth of a business if it does well and often receive a share of the profits through dividend payments. Sharing in the profits and growth of companies means your capital is potentially exposed to losses, but over long periods of time history shows that investors often benefit from taking these risks.
Leaving money in cash may be the lowest risk approach, but it provides very little return and is unlikely to grow fast enough to keep up with increases in the cost of living; though it does have the important advantage of keeping capital secure. By compounding more volatile stock market returns, and ignoring short-term noise, you give yourself a better chance of meeting long-term financial goals. There are some examples of low maintenance investment strategies here.
Dont forget to invest tax efficiently
It also helps to invest tax efficiently so you keep more of your returns. Using an ISA to house your investments means income and capital gains are tax free. This is also the case for pensions, plus you receive a tax relief boost from the government when you invest.
This article is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investors should be aware that past performance is not a reliable indicator of future results and that the price of shares and other investments, and the income derived from them, may fall as well as rise and the amount realised may be less than the original sum invested.Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice. Tax reliefs are those currently applying and the levels and bases of taxation can change. Tax treatment depends on the individual circumstances of each person and may be subject to change in the future.