Strategic Insights │ Investing Principles

Strategic Insights │ Investing Principles

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Investments
Financial Planning
Inflation
Published
Published July 1, 2022
At IQ, our investment team is made up of experienced analysts-cum-futurologists. And if there’s one thing that we have learnt, it is that the key to successful investing is not so much about predicting the future… as it is about learning from the past and understanding the present.
 
Not for decades has the present been characterised by so many challenges, so many uncertainties and so many unknown unknowns. Nevertheless, there are still a number of tried and tested principles that we believe will see you through today’s challenges and help you achieve your goals tomorrow.

Trust in your financial plan and stay the course

It may seem obvious, but good financial planning involves… having a plan. And the plan that we fashion for you at IQ will be unique to you – unique to your personal circumstances and finances. It will be underpinned by your short-term goals, as well as your medium- and long-term ones, and based on your attitude to risk (as well as your capacity for loss). Although this plan may need to be tinkered with, retuned, rejigged and revamped over time as your personal circumstances change (and as life throws its inevitable curveballs at you), you should not deviate from it based on whatever the markets might be doing on a particular day… or even over a particular year.
Riding the ups and downs of the markets can be uncomfortable. But a comprehensive financial plan is only as good as your ability to stick to it through thick and thin. Once you have your plan, we will check in with you periodically so we can review it together. By focusing on the long-term plan, you can tune out the short-term market fluctuations and the noise of the day-to-day headlines.

Keep some cash…

It is sensible to keep some cash reserves – particularly when the markets are so volatile. Life is full of those proverbial leaky roofs and broken boilers, and it is always useful to be able to get your hands on sizeable sums without too much ado. That said, a five-minute blast of the evening news can be sobering. Even before Russia invaded Ukraine at the start of this year, UK inflation stood at around 5.1% – more than double the Bank of England’s 2% target rate. Now it’s at 9.1% – the highest rate in 40 years, and it is generally thought that it will reach 11% within a matter of months. Cash is indeed something of a safe haven in times of uncertainty. But interest rates relative to inflation are still extremely low, leaving your cash savings vulnerable to erosion over time. Current market volatility should be balanced against the nefarious effects of inflation.
This steep rise in inflation can no longer be described as only temporary, and inflation is universally recognised as the “silent thief” that decimates your cash reserves. Even in lower inflationary times, in practically every scenario, cash underperforms over the long term. So definitely keep enough to finance your way through one to two years of necessary expenditure, but do not sit on mountains of it.

Fire, the wheel… compound interest

The first written evidence of compound interest actually dates back to roughly 2400 BC… and since then  Albert Einstein even dubbed it the eighth wonder of the world.
So great is the power of compounding that even missing out on a few years of saving and growth can hit your eventual returns hard. Even the most basic example speaks volumes: if you start investing £5000 per year at the age of 25 at a rate of 6%, you would have over £400,000 more by the age of 65 than you would have had you started at the age of 35. This is despite the fact that the overall difference invested would only be £50,000.
So embrace the eighth wonder of the world… and fully leverage the magic of compounding by reinvesting any income from your investments if you don’t need it. The difference between reinvesting the income from your investments and not reinvesting it over a long time can be enormous.

Volatility – the key takeaways

June has been a dire month for the S&P 500. The international press has been full of words like “crash” and “meltdown” as market observers watched it lose a significant chunk of its value. But the reality is that falls of this magnitude have happened throughout history and are simply a feature of the markets: 1987’s Black Monday, the Dotcom crash, the global financial crisis of 2008 and the Covid-catalysed March correction, to name just a few examples from the last few decades.
But just as it is important to distinguish drama from mere intrigue, we should differentiate between market corrections, and market crashes… and significantly more serious events that attract labels such as “depression”, “meltdown” and “Armageddon” from the headline-hungry press. Corrections are 10 to 20% falls in the stock market. They happen every year or two, and the average fall is 13.7%. They last four months on average, and recoveries (back to pre-correction levels) have taken four months on average. Crashes are falls of more than 20% and happen once every four years on average. The average fall is 32.5% and they last around 14.5 months; recoveries have taken two years or so.
Since the Second World War, there have been 27 market corrections. But more significantly, the average return in the 12-month period following the losses incurred was more than 16%. Even more importantly, 80% of corrections over the past 75 years have not turned into crashes. And – as the archetypal blurb is so fond of reminding us –while past performance is not a reliable guide to future performance, so far, every single stock market crash has been followed by a recovery that more than made up for the fall.
By way of a parenthesis, comparisons between the current turmoil and the Great Depression of 1929 are not wholly justified. There are indeed problems ahead – mainly because of the sheer number of unknown unknowns (and the fact that it is impossible to know Putin’s mind). But a century ago, we did not have the technology that we have today, there was a complete absence of central bank policy and there was all-round poor basic governance. In short, we can rest assured the economic cost of Putin’s incursion is likely to be somewhat more manageable.

Don’t get emotional

Your emotions should never be allowed to govern your investments.
When Warren Buffett talked about “time in the market”, rather than “trying to time the market”, what he was essentially saying was that the biggest temptation is to do something in a downturn, but the smartest decision you can make is to do nothing. Tune out the outside world, tune out all the news – good and bad – and just continue doing what you are doing. In fact, if you invest regularly over time, come rain or shine, you benefit from pound cost averaging. Regular investing month in, month out – no matter what the state of the market – will teach you to keep your behavioural nerve and adopt a non-emotional approach. You will buy high, low and everything in between… and you will capture the average return of the market. Do not necessarily expect the same rates of return in the future as we have seen in the past. But an appropriate blend of stocks and bonds is likely to protect you against a negative return over any ten-year rolling period.

Lots of eggs, lots of baskets

The first two decades of this century have brought with them the September 11 attacks of 2001, the Dot.com crash, the global financial crisis, Brexit, Covid… and most recently, war in Europe. These world-changing events have come thick and fast, meaning a great deal of volatility for investors.
And yet, despite this tumultuous ride, the worst-performing asset classes have still been cash and commodities. Even against a backdrop of geopolitical turmoil, a well-diversified portfolio made up of stocks, bonds and a sprinkling of other asset classes is a better bet for investors than investing simply in equities.