Even though stock markets are generally having a bad time of it at the moment, as an investor there is no need to panic unduly. There are several strategies you can adopt to ease the pain and to protect your portfolio in the current environment. Let’s start with a little perspective on the situation.
At the start of 2012, it’s worth looking back at 2011. There was the major natural catastrophe in Japan for starters. Then there were problems in Greece and other sovereign European states, culminating in threats to the Eurozone as well as the Euro itself – plus of course the downgrading of the US credit rating. There was no doubt that the media seemed to revel in the bad news and as bad news sells, this is sure to continue.
Certainly investors voted with their feet, as they staged the biggest retreat from the stock market in 20 years. According to the latest figures from the Investment Management Association, private investors pulled a record £864m from investment funds in November, bigger than the retreat from the crisis of 2008.
But what effect did all these problems actually have on the markets? Well, in Europe, unsurprisingly most markets ended down for the year. The FTSE 100 lost 5.6 percent, whilst Germany’s DAX lost 14.7 percent. Interestingly, Far East and Emerging Markets also suffered, roughly along the lines of Europe. Overall Emerging Markets were down 14.5%, Japan was down 14.1% and Pacific ex Japan lost 10.9% – so simply avoiding European equities was not a solution.
However, as reported in the Guardian, in the US, the Standard & Poor’s 500 index closed 2011 just a fraction of a point below where it started the year. The S&P closed at 1,257.60, compared to 1,257.64 at the end of 2010. So its loss for the year was just 0.04 point. The Dow was up 5.5 percent for the year, whilst the Nasdaq composite index lost 1.8 percent.
So the US is not looking in too bad a shape and there are encouraging trends there as well, with some improvements on the unemployment and housing market fronts. Obviously there is an election later this year so the issues of debt and deficit are likely to be put on hold until 2013, but there are at least glimmers of hope.
Away from equities, bonds did well in 2011 which is somewhat surprising as they usually do badly in times of rising inflation. Long term gilts (over 15 years) returned 24.3%, index-linked gilts returned 15.4% and all gilts on average returned 14.2%. Corporate bonds which are normally riskier than gilts returned 7.1%. Elsewhere, gold returned 25.3%.
Because of this, well diversified investors will have been cushioned from the fall in equities via their holdings of gilts, bonds and other asset classes.
So how do you keep your portfolio ticking over in these difficult times?
Well, firstly, by playing a long-game. As investors in equities know, the whole process is a long-term game, and losses are only crystallised once the funds are eventually sold. So don’t panic – and hold onto your equities.
Secondly, you should ensure your portfolio is diversified. If you have a well-diversified spread across a range of asset classes, it is more than likely that if one area goes down, other asset classes should help provide protection.
Thirdly, you should look to rebalance your portfolio. As 2011 was a fairly volatile time for markets, it is likely that the portfolios of most investors are somewhat skewed, and will need rebalancing to get back in line with their model asset allocation. This might mean selling some gilts or bonds that performed well last year, to get their portfolios back in line.
Fourthly, you should consider a focus on income. Higher yielding stocks tend to outperform low yielding stocks over the long term and can contribute towards total returns if the dividends are reinvested. In fact 2011 was a not a bad year if you invested in good quality, long-term, dividend-paying companies. According to Capita Registrars, 2011 was a record year for dividend pay-outs, with investors in UK companies getting a £67.8bn bonanza – up 19.4% on 2010. Record dividends therefore provided a real bright spot for investors in an otherwise gloomy world.
Finally, if you are still looking to invest but are a little nervous, you should consider “pound cost averaging” – the process where you invest amounts on a regular ongoing basis rather than as a lump sum. This process helps to smooth out your investment returns, as when share prices are low you end up buying more shares – but obviously fewer when the price is high. So when the market is depressed, you benefit by buying more shares, which will be good news when the stock markets rise again.
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