A recent Telegraph article looked at the case of Douglas*, who held £345,000 in cash, and wanted to know if - and how - to invest it. The article suggested there were at least two main concerns about what to do.
First of all, inflation is sitting at nearly 9.1% in May 2022 meaning that real returns from cash (i.e. those after inflation and tax) are impossible, due to low interest rates.
Secondly, however, is now a good time to invest a cash pile in the stock market given its recent volatility? The S&P 500 - formerly at an all-time high in December 2021 - has been moving in a downward trajectory since the new year started.
In the UK, the FTSE 100 is up from 12 months ago, yet there has been volatility along the way.
All of this raises important questions - how should Douglas, or you, invest when markets are uncertain? Is it best to wait until conditions improve before committing a lump sum? Should you, instead, invest your money gradually (“pound cost averaging”)?
Establish your risk tolerance
Many people view investing as risky, yet it is important to recognise that, in 2022, cash is no haven of safety. In fact, holding too much is a near-certain loss. If, for instance, you have £300,000 in a regular savings account at 1% interest, but inflation is 9%, then if this holds for a 12-month period you will make an 8% “real” loss (despite your bank statement showing that you have earned more interest). Financial planners therefore recommend you keep a cushion of cash in easy-access vehicles to allow you more flexibility.
Over and above this cushion, investing the rest is a good idea to grow and/or preserve your wealth over the long term. But it’s wise to establish your risk tolerance (or “appetite”) early on. This makes it less likely that you will make impulsive decisions when markets are volatile, such as selling shares in a bear market (which crystallises your losses). Jumping in and out of the market - trying to time it - is one of the worst things you can do as an investor. So, establish a strategy early on that you are happy with, and can refer back to when markets become unstable.
Marry your goals and investment horizon
What do you want to achieve with your investment portfolio, and how long is it until you will need the money? Having a clear vision is helpful to staying the course in turbulent markets. If you plan on accessing your funds within 1-5 years (perhaps to put down a deposit on a property), then your investment “horizon” is relatively short. This encourages a more “cautious” investment strategy, where maybe more of your portfolio comprises A-listed bonds and dividend-paying equity funds with a history of low price volatility. This helps protect your investments if there is a stock market fall during your investment window (but as always, there is no guarantee and investments can still go down as well as up).
If, however, you are investing to build up a retirement fund and you are still early in your career, then you can take more risks (to access higher potential returns). The stock market, in particular, is quite volatile in the short term and may even experience periodic falls. Yet, over the long term, equities have historically risen. To take the S&P 500 as an example, this has fallen by 6.21% over the last 12 months. Yet between 1957 to 2021, it has averaged 10.5% per year.
Even with longer investment horizons, however, you still need to take steps to mitigate needless risks. Diversifying your portfolio across multiple markets, companies and asset types is one way to achieve this - spreading your investments out so they are not overly-exposed to any risks that are associated with any particular one.
Gradual vs. lump sum investing
Some people will be investing on a regular basis - putting some of their monthly salary towards pension funds, for instance. However, what should you do if you come across a lump sum of cash to invest (e.g. from a sudden inheritance windfall)? This can be particularly challenging during uncertain markets. Many people are reluctant to invest a large amount of money at once. After all, what if you do so and the markets drop further, soon afterwards?
In such a situation, a delicate balance needs to be struck. On the one hand, holding too much cash for too long means it will suffer a “real loss” in a high-inflation environment (as we are now, in 2022). However, you do not want to be reckless with your money. Here, it can be helpful for some people to gradually “drip feed” the money, into a portfolio over time (e.g. 12-24 months).
This “pound cost averaging” approach may not be as efficient as investing a lump sum over the long term, but it can lower the average price you pay for shares during a volatile market. If you have a lower risk tolerance, this can help you stay invested when your emotions are pulling at you.
Work with a trusted adviser
Using a Chartered financial planning firm can be hugely helpful if you’re looking to build - and improve - a strong portfolio that helps carry you through volatile markets. Not only can they identify opportunities and risks in your strategy that you may have missed, but your planner also acts as an important “sounding board” for your investment questions and worries.
Getting an authoritative opinion could make all the difference to helping you stay the course.
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest.