How do you protect your investments against market volatility? Whether you have £10,000 or £10m, many of the same rules around investing apply. You need to focus on the long term.
Stock markets are going to be increasingly volatile – a measure of market risk – so it is important to be realistic in your expectations for investment returns.
Your key considerations for deciding where to allocate your money are risk, diversification, and liquidity.
We advise concentrating on the five big strategic investment decisions you need to get right in order to weather the “volatility storm”.
Liquidity is key
When it comes to protecting your investments against market volatility, liquidity is essential. At least 80% of your portfolio should be in liquid investments, i.e. cash or cash-like financial instruments.
This is not because we think the world is falling apart, but because we believe there will be buying opportunities for investors over the next few years.
Part of this strategy is to keep about 30% of your investable assets in cash and short-dated bonds. If the worst were to happen (the so-called “Black Swan” event), the pricing of all major asset classes – bonds, shares, property – would become highly correlated.
In this event, cash and short-dated bonds would be the only real way to diversify your risk from financial markets. Traditional asset allocation and portfolio diversification would go straight out of the window.
Depending on your base currency, we would recommend sticking to top quality government bonds over the longer term – UK gilts, German bunds and US treasuries only.
We advise most of our clients not to own government bonds with more than two years in maturity. High quality short-dated corporate bonds are an alternative and can offer more returns over cash and government bonds, but are riskier.
Investors should avoid taking significant credit risk and interest rate risk, and remember that chasing yield, or income, is the worst thing possible.
Note that all cash-like investments should always be in your base currency. Investments in other non-base currencies are speculative in nature and just add more risk to your portfolio.
Avoid ‘gold hype’
The big global investment players have already made their long-term money allocations to gold. Although we recognise that prices may yet go higher, we would not be allocating new money to gold at current market levels.
Gold remains in bubble territory and anyone buying at these levels is basically speculating, not investing. When market volatility is high, investors sell their gold, as it seems to be viewed as a short-term provider of liquidity or cash.
When markets recover, investors again sell their gold and then reallocate their money into riskier assets, such as shares and commodities.
Pay attention to shares
It is important to remember that company profitability and earnings are what drive share price rises, not geopolitical events. Over the long term, we are encouraged by fair valuations in many international stock markets, along with better-than-expected earnings numbers.
The US is still the engine of the world economy, and bigger than the combined economies of China, Japan, and Germany. If you want to put your money into property, hedge funds, and private equity, then be sure to keep your exposure low.
Remember, you are taking much higher risks when putting your money into these broadly illiquid “alternative investments” than if you invest in global share markets.
Commodities and emerging markets
It makes sense to have a significant long-term allocation to oil, agriculture and specific emerging markets. After a long period of caution, we have recently become more optimistic about commodities and emerging markets.
While global investors are getting caught up in the short-term panic around recent geopolitical events, inflation and asset price bubbles, the fact is that emerging markets look fairly priced and many basic commodities have slowly started to recover from their recent lows.
Exposure to commodities and emerging markets is a long-term play on the global recovery and gives some diversification to an investment portfolio.
Avoid high fees
Last and by no means least, remember that fee leakage equates to wealth destruction over the long term. Total fees should be no more than 1%. This includes management fee charges, execution costs, custody fee charges and any rebates, which should always be returned to you as the client.
When you see a financial adviser, make sure that you ask plenty of questions, understand clearly what the total charges are, and don’t be afraid to switch advisers or negotiate them down where charges have become excessive.
You should expect complete pricing transparency from your investment manager. We believe it is not in your best interests to be in high cost “alternative” investments and we do not invest in so-called “structured products”. These only serve to make the banks wealthy.
Global markets are not great at the moment, but there are positive signs that, over the longer term, problems will get resolved and markets will improve.
Do not get caught up in all the short-term noise, and above all do not trade or speculate around uncertain geopolitical events.