We’re all aware of the current crisis in Europe and the war between Russia and Ukraine. The first two months of 2022 have been very difficult from an investing perspective. January, we faced and continue to face inflationary pressures, and in February, the war in Europe commenced.
Many of our clients have inquired about the current issues and our perspective on investment strategies in 2022.
In reality, it is impossible to guess how investment markets will perform not just in 2022 but also every year. The picture below shows the variation of returns year by year for the major investment markets. As you can see, each market will perform differently each year, so it is difficult, if not impossible, to predict. For this reason, holding a diversified portfolio of assets does two things. Firstly, it spreads your risk and also reduces the volatility of your investment or pension portfolio.
Even with all the current problems, we still believe the same tried and tested investment principles should be followed and adhered to. We understand the concerns clients might have and the initial reaction clients might have when it comes to times of uncertainty. The principles are:
- Use a long term investment strategy – Ideally, investment portfolios should be kept for a minimum of 7 years. Short term fluctuations in equity and bond markets have less of an impact the longer you invest.
- Portfolio diversification – Having a diversified portfolio of different assets reduces the volatility of a portfolio. For example, if you invested in a portfolio of purely Russian companies several years ago, you would not be able to trade the portfolio due to the current crisis, and you would have suffered significant losses. A global portfolio would have seen losses since the start of the year, but nowhere near as much.
- Stay invested and try to ignore investment noise – With 24 media coverage of world events, it’s easy to get distracted from the long-term principles of investing. It’s important to ride out any short-term fluctuations in investment values.
- Be tax efficient – Use tax allowances and tax planning such as ISA and CGT annual allowances.
- Be aware of the latest fads and trends regarding investing – Over the years, myths and trends seem to rise to the surface and detract from tried and tested methods.
Over the years, clients have also enquired about many other types of investments. All have their advantages and disadvantages. Here are just a few aspects of investing that clients have inquired about over the last few years.
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Is gold a good investment?
Investing in gold has traditionally been viewed as an effective way to diversify a portfolio. The general opinion is that buying gold is a good hedge against inflation and is, therefore, an important investment strategy. In difficult economic times, people turn to gold rather than other investment strategies. Therefore, many investors have made a small investment into gold, whether through an Exchange Traded Fund (ETF), a regular fund or by purchasing physical gold. However, do the figures back up gold’s reputation, and should you invest in gold?
As with anything, there are arguments for and against making a gold investment. There is evidence to suggest that it does act as a hedge against falling equity markets. Between 2006 and 2012, when the financial crash took place, gold provided significant returns on investment. This demonstrates that money-flows into gold increase as investors show concern over other asset classes. Since gold is a finite resource, it is considered a reliable store of value because there can only be so much supply. Therefore, while it may not grow significantly, it is unlikely to experience large amounts of volatility compared to stock markets.
However, compared with equities over a longer period, the returns from gold do not fare so well. The graph below compares the price of gold, silver, S&P 500 and Dow Jones over the last ten years. This clearly shows that returns from the equity markets have been significantly higher since 2012 than those of gold and silver. Overall, gold has seen almost no growth, whereas the S&P 500 index has grown 300%. Furthermore, there is the added logistical issue of holding physical gold. Storing the gold safely can be difficult and stress-inducing. The other problem with physical gold is that you cannot hold it within a tax wrapper, so you are liable to tax on investment income, arising when your gold increases in value.
On balance, it is clear that gold has its place in the world of investment strategies but should not be used on its own as a source of investment returns. Holding a small amount as part of a diversified portfolio is sensible due to its qualities during economic shocks.
Buy to let property
Buy to let property can be a worthwhile investment, especially if you want to invest long-term. However, there are several important points to consider.
When you purchase a UK buy to let property, stamp duty is currently 3% higher in the UK. You will also incur costs for the purchase on top of stamp duty.
Property is classed as an illiquid asset and not easily saleable. If you need to sell a property quickly, you might have to reduce the price to sell it quicker. Also, there is likely to be costs associated with the sale that will impact the eventual return on the asset.
Although property prices have increased in value over the years, there is no guarantee this will continue in the future. This is not an issue if you intend to hold the property for a long time, for example, ten years or more.
- Stagnant rental yields – If the property’s value increases, the rental yield as a percentage will fall unless you increase the rent you receive. However, it might not always be possible to increase the rental return.
- Void periods – Unless you have a long-term tenant, then it is likely that you will experience periods when the property is vacant. This will impact the overall return.
- The hassle factors – Some tenants will be fine, but others can be a pain in the backside. Problems can include late payers, awkward tenants who phone you at inconvenient times for work and repairs, and tenants who treat the property badly. Nonpayers that you have to evict. Whilst these are problems you might be able to deal with, the hassle becomes more of a problem as you get older, especially into retirement.
- Maintenance costs – Annual repair and insurance, testing and fees to property management companies reduce the overall returns you receive as an investor.
- Disposal costs – The highest disposal cost is usually capital gains tax. CGT is only payable on the asset’s sale, so if you intend to hold property and not sell it, then it’s not so much of an issue. However, the longer you hold property subject to CGT, the bigger the tax problem’s potential becomes. The reluctance to sell a property and incur a sizeable tax bill is not attractive. If you gift the property to your children, it is possible to “rollover” and defer the capital gains tax, but it doesn’t solve the issue.
- Rental income is taxable – Any rent you receive is taxed as income. The amount of tax you might pay depends on your total income. This could be up to 45% of the rental income. Although you can offset certain expenses against the rental income with the aim of reducing your overall liability.
Property can be an attractive investment to hold, but again we would recommend to our clients that it is part of an overall investment portfolio rather than a major holding.
Investing in Bitcoin
What is Bitcoin?
Bitcoin is a digital currency that was set up in 2009. It was the first cryptocurrency in existence and has grown to have a market cap of over $1 trillion. Despite having no tangible value, the popularity of Bitcoin has risen exponentially since its inception. Many regard Bitcoin as akin to a digital version of gold due to its finite supply, market demand and cost of production. Bitcoin is mined, similar to gold, but using vastly complex algorithms. The energy required from a computer to mine a Bitcoin is significant, and the supply is restricted by coding that was setup before Bitcoin was launched. This is programmed so that the supply of new Bitcoins is halved roughly every four years.
In recent years, attention around Bitcoin has grown due to its extreme volatility. Thrill-seeking investors have poured money into Bitcoin, hoping to see life-changing gains, but many have lost out due to Bitcoin’s tendency to plummet in value suddenly. Due to various factors, there has been a rise in DIY Investors, particularly since the Coronavirus Pandemic. With interest rates low and equity markets struggling, young investors in particular have turned to alternative investments, Bitcoin being one of them.
What are the dangers of investing in Bitcoin?
There can be no denying that Bitcoin has performed well since starting in 2009, but many experts believe this is a bubble waiting to burst. This is why most countries, including the UK, do not regulate the trading of Bitcoins. Without regulation, investors risk losing all of the money they invest and are not covered by the Financial Services Compensation Scheme. Should trading platforms collapse, there is no fund available for investors to get their money back. The lack of regulation from the Financial Conduct Authority is also a signal of the significant risks involved, and they send a strong message that caution should be exercised when speculative assets such as Bitcoin are considered for investment.
Secondly, the volatility in the price of Bitcoin is unprecedented and leaves investors seriously exposed. One way of demonstrating this is that the volatility value for Bitcoin over the last 12 months was 81.87. To put this into context, the volatility for a fund of world equities was 8.55, meaning the price of Bitcoin has fluctuated on average almost ten times more than the equities fund. Most investors would feel that investing in 100% equity is too much risk, but these figures suggest that investing in Bitcoin takes 10x the level of risk!
Furthermore, Bitcoin is prone to sudden crashes in value. Most significantly was the crash in 2017-18 following a short-term explosion in price. The below chart shows how the price fell from $19,363 on 19th December 2017 to $6,848 on 31st March 2018. This was a drop of 64.6% in the space of 3 months!
(Bitcoin price from December 2017 to April 2018 – Source: CoinDesk)
Another reason to be wary of Bitcoin is the number of scams related to this asset. Due to the high level of inexperienced investors, many scammers are looking to hunt easy prey. With promises of life-changing returns, they lure people in, and thousands have lost their hard-earned savings. Since Bitcoin is not a regulated product, there is no chance of retrieving the money through compensation. The general lesson is that if it appears to be too good to be true, it usually is!
Should I invest in Bitcoin?
As outlined in the sections above, many risks are investing in Bitcoin. It is a speculative asset with no tangible value, and most experts are still scratching their heads, wondering where the use case is for this digital currency. We would not recommend investing in Bitcoin or other cryptocurrencies for those reasons. If you decide to invest, ensure you do sufficient research on the risks beforehand and are fully prepared to lose 100% of the money invested. Only time will tell whether Bitcoin has a place in our financial system for the long term, but for now, the risk that it will become worthless is too great.
Peer to Peer lending
Peer to Peer Lending (P2P) is where a savings platform attracts investors, usually with a higher rate of interest, when compared to the major banks or building societies. These accounts are not like traditional savings accounts as the returns are not guaranteed, and the Financial Services Compensation Scheme does not usually cover you. P2P lending aims to match savers who are willing to lend money with individuals and companies looking to borrow. The advantages to savers are the higher interest rate that is payable and borrowers a rate of interest that is more competitive than the banks.
The P2P platform essentially cuts out the middlemen and receives its profit via levied fees. Although borrowers are checked for creditworthiness, there is no guarantee they will maintain and repay the debt in the future. Any bad debts are shared amongst the savers. Essentially P2P is investing rather than saving. Although P2P might seem attractive and could, in certain circumstances, be appropriate, there is a limit in terms of how much new retail investors can put directly into P2P lending. The Financial Conduct Authority has recommended a maximum of 10% of investible assets. If you are a professional investor or using the services of financial advisers, this limit can be increased.
Trying to time the market
It can be a very tempting idea for new investors or even experienced investors to attempt to outthink the market and time when you buy and sell. Looking back over time and seeing price fluctuations can lead to thoughts similar to “imagine if I bought in this dip and then sold here at the top”. This is all very well in theory and far easier in hindsight. Timing your decisions in real life is near impossible, and that is why no investor, not even the most experienced professionals, have successfully timed the market consistently. Of course, there is always the odd success story, but whether that is down to luck or skill is a different debate.
So why is timing the market so difficult to achieve yet tempting to try? Firstly, we are all human. As humans, we like to convince ourselves that something will happen in the way we expect, particularly if we have read the same opinion online or had a friend confirm our suspicions. We also have emotions, which dictate our decisions more often than they should. Therefore, trying to put emotional feelings such as greed, doubt and fear aside and invest purely in facts and evidence is not straightforward. Money triggers stronger emotions than most other aspects of life, and investing is all about money.
The raw statistical probability also supports the idea that timing the market is hard to do. A successful investing move involves two correct decisions. One is buying at the right time, and the other is selling at the right time. Putting any rationality aside, there is a 50% chance of getting each decision right. This means that the chance of getting both decisions right is only 25%. That is before even considering that markets love to follow the path of most pain.
A recent example that shows how difficult it can be to time the markets is the Covid induced crash of 2020. In March 2020, markets plummeted by more than a third and by May 2020, there were no reasons to be positive. Thousands of people were dying every day worldwide, and most of the population were in lockdown. Logic would dictate that the markets will continue to fall, and some investors will have thought they are wise to sell on the way down and then buy at the bottom. Perhaps the bottom would arrive once Covid was under control and vaccines were being rolled out? That is one of the biggest problems – how do you know when the markets have fallen as much as they can? Of course, the markets followed the path of most pain and recovered far earlier than anyone expected, and at some rate too. By June 2020, most markets had bounced back to the levels seen at the start of the year and subsequently continued to rise. Those investors who had the clever idea of selling and buying back later missed out on all that growth, as they were waiting for ‘the bottom’.
In summary, there are many reasons why it is not wise to time the market. Even if you can separate logic and emotion, more often than not, the logic and evidence will not lead to correct decisions. The recommended strategy is an idea called pound cost averaging. This involves buying at regular intervals no matter the price and takes out any emotion or decision making from the process. Adopting this strategy means that you benefit from lower prices and will also buy during peaks, but overall you perform better because, as the saying goes – “the important thing is time in the market, not timing the market”!
How to prepare for a market crash
Although we never like to consider the possibility, it is inevitable that sometimes the stock market will fall. It is never clear when or why it will happen, but the next crash is always just around the corner. These events are usually known as black swan events. They usually come out of the blue when people least expect them. Although you cannot predict or prepare for these events, accepting them as part of the overall investing cycle will help somewhat.
A market crash will come.
The first stage of preparing for a market crash is to accept that it will come. There is a common misconception among inexperienced investors that the stock market will simply grow in value forever and that losing money isn’t an option. This is called recency bias, as investors expect the future to reflect past increases in the value of their investments. History tells us this is not the case. Sometimes it could be a significant world event that leads to such a crash. Examples of these include the 9/11 terrorist attacks in 2001 and the Covid pandemic. On other occasions, there are more complex economic reasons for it. The most recent example of this is the financial crisis around 2008, which began because banks were running out of money due to various factors. Market crashes are part of the investing process and should not be feared, leading nicely to the next point.
Stock markets always recover.
Knowing that the markets will recover is almost as important as accepting it will happen. Normally, they recover faster than one might expect. Every market crash in history has been turned around, no matter how big the dip. Take the crash in 2020 as an example, when the Covid pandemic hit and stock markets plummeted. Between 12th February and 23rd March, the US Dow Jones Index lost 37% of its value. The fall was so dramatic that the Government closed the stock markets for five days as an attempt at damage limitation. Investors sat back as their life savings disappeared with every passing day.
However, in April 2020, the recovery began. Despite large unemployment numbers and eye-watering debt levels, the markets began to turn around. By November 2020, the Dow Jones surpassed its February level and broke the record for the highest it has ever been. Similar themes were seen across the other major global economies. The lesson here is that the markets will eventually recover no matter how uncertain a situation appears. Below is the chart for the Dow Jones throughout 2020, reflecting how quickly things can change.
(Dow Jones Index price during 2020 – source: Investopedia)
Do not panic sell
Following that is the fact that you have not made a loss until you sell your investments. This means that when the market has crashed, and you are ‘down’ by 20%, you have not lost that value because it is only a reflection of the current state IF you sold your investment. The worst thing you can do is panic sell during a market crash. This is easier said than done because human instinct tells us that we should cut our losses and run away when things are bad. That does not apply to stocks and is one of the worst investment strategies you could take. Going back to the previous point that markets always recover – this tells us that selling when it is low will only mean we need to buy back again once they have gone up. The table below reflects how this investment strategy would have fared in 2020 compared to holding on and waiting for the recovery.
Assume two investors held £10,000 in the Dow Jones Index at the start of 2020:
As the table shows, holding on during the crash meant that the investor finished the year in profit, whereas the investor who panicked and sold during the dip still had a loss by the end of the year. The main reason why the market always bounces back is that the central banks and the Governments have many tools that they can use to trigger a market recovery. Examples include changing interest rates, public borrowing and providing financial aid to people or businesses.
Hold a diversified portfolio.
Now we have covered ways to prepare yourself for the next market crash mentally, but there are ways you can prepare your investments too. Having a diversified portfolio means investing across a range of asset classes, geographic regions, and industries to spread your risk. Whilst investments such as stocks are often highly sensitive to poor economic conditions, other asset classes such as bonds are more stable in these times.
Generally, asset classes can be split into growth assets and defensive assets. Growth assets, such as stocks tend to increase significantly in value over the long term. The downside is that they are highly volatile along the way. On the other hand, defensive assets would see modest growth over the long term but take a slow and steady route to get there. Examples of these include cash and bonds.
Therefore, a portfolio of 100% growth assets would suffer most during a market crash, but this can be managed by holding an element of defensive assets. Getting the right allocation of assets is difficult and depends on your situation and attitude to risk. Seeking investment advice can help you to gain an understanding of your recommended asset allocation. Not only that, but professional investment managers are highly trained and experienced in deciding which shares to buy and which assets can maximise performance.
To demonstrate this, we will go back to the Covid market crash from 2020. The graph below compares the performance in 2020 of a portfolio holding 100% equity with a portfolio holding 50% equity and 50% bonds. As you can see, the red line of the 50/50 portfolio does fall in March and April, but not nearly as much as the green line of the 100% equity portfolio. Reducing the severity of the crash can significantly ease the anxiety and concern that you feel during the most uncertain times, as well as the potential financial loss.
Regularly review your investments.
There are several reasons why it is vitally important to review your investments at least once a year. The first reason is that investing in line with your attitude to risk means that when the inevitable market crash does happen, you can be safe in the knowledge that you are not taking more risk than you feel comfortable with. Part of the investment planning process measures attitude to risk, and a significant portion of that is understanding how you would feel should your investments fall in value. This should be revisited regularly because an investor’s attitude to risk can change quickly depending on life events, personal situations and economic conditions. In addition to attitude to risk, there is also the capacity for risk, which is equally as important. If the money you have invested in supplying you with income and therefore critical to maintaining your standard of living, you should be holding mostly defensive assets.
The second reason to regularly review your investments is portfolio drift. Portfolio drift refers to your investments becoming out of balance when some parts perform better or worse than others. Over time, this leads to you taking far more risks than you think you are and more than you are comfortable with. Therefore, portfolios should be rebalanced at least once a year so that the mix of growth assets and defensive assets is a match for your attitude to risk.
This example demonstrates the effects of portfolio drift:
Assume you have invested £100,000 into a portfolio holding 60% equity and 40% bonds. This matches your attitude to risk, and you are comfortable with the level of volatility you may experience.
However, your equity holdings are growing faster over the years than your bonds. Assume your equities achieve 8% growth per year, and the bonds only 3%. Your split of assets will be as follows:
Total = £100,000
Equity = £60,000 = 60%
Bonds = £40,000 = 40%
End of year 5
Total = £134,531
Equity = £88,161 = 66%
Bonds = £46,371 = 34%
End of year 10
Total = £183,292
Equity = £129,535 = 71%
Bonds = £53,757 = 29%
By the end of year 10, you are holding 71% equity and therefore taking far more risk than you initially wanted to take. Furthermore, we generally become more risk-averse as we get older. Portfolio drift slowly increases the risk you are taking over time whilst your attitude to risk is becoming more cautious.
Annual rebalancing of your portfolio can avoid this and ensure you remain invested in line with your updated attitude to risk. Alternatively, you can use a discretionary fund manager who rebalances your portfolio more regularly to maintain your risk profile.
Remember, investing is a long-term strategy. Try to ignore the day-to-day information that can affect the values of your investments. Whilst we might be concerned, it’s worth remembering the following strategies
- Hold a diversified portfolio
- Control the risk within your portfolio
- Don’t try and time the market
- Investing is a long term strategy
- Control the overall cost of investing
- Rebalance and review your investments regularly
- Make the most of tax allowances and strategies
- Avoid the latest investment trends such as gold, commodities and bitcoin
- Don’t panic sell
- Markets will recover
We have extensive experience when it comes to investment and pension advice. If you would like to discuss your existing or new investments, don’t hesitate to contact us to arrange an initial discussion.