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3 September 2015
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With the FTSE 100 slipping to its lowest level in almost three years, Sterling posting its biggest drop against the Euro in six years, the Dollar tumbling and Chinese shares generally dragging down nearly every market in the world, it would genuinely seem that what market enthusiasts correctly titled ‘Black Monday’ was a day to remember.
The Markets all over the world are jittery, nervous and so far dropping off. So to give you some support, we have written a quick strategy list to get you through this tough period by considering some fundamental, but often forgotten investment techniques.
Historically markets that have strong movements in either direction induces a certain level of emotion such as fear, anxiety, euphoria, regret and blind-optimism, depending on which direction they turn.
A less experienced investor may allow these emotions to control their market decisions. Depending on the circumstance this can be either destructive or profitable, and the investor may not even know why!
The truth is successful investors have a common denominator. It’s nothing ground-breaking, nor is it new. They all stick to their well-thought-out plan to a tee and have the discipline necessary to keep a level head.
In short, they stick to their strategy.
Investors can’t be blamed for allowing emotion to take over when the markets turn. This is your money we are talking about!
I talk to and help a large variety of investors. One of the most common problems I see is that investors have failed to build in the adequate level of diversification to keep their portfolios sustainable in times of market turbulence.
Again, this is nothing ground-breaking. In fact, a lot of what I will tell you about today, you have probably heard before. However, it is staggering how often it is overlooked or becomes lost or forgotten amongst the more ‘exciting’ side to investing.
If you are serious about investing and your portfolio’s future, take the below strategies to heart. Ask yourself; do you follow these simple but effective procedures to help prepare you for whatever the market throws at you?
Do the stocks you hold in the portfolio today still have the same fundamental reasoning behind holding them as they did before?
Re-evaluating and determining your portfolio strength on a frequent basis is not necessarily an excuse to make continuous changes (if it does, I would suggest you reconsider your original investment criteria!) but more a reason for you to align how the current portfolio stands, with the reasoning behind the initial investment criteria.
For example, are those stocks which have been plodding along and not really doing much still worth the cash they take up? Do they still meet your investment requirement for stocks that you would consider buying at present? If not, it might be worth considering what options are available to you.
In a circumstance where the markets pull back, these are likely to be some of the stocks which will become a burden for a portfolio.
The key lesson here is to make sure you understand your portfolio’s strengths, its potential weaknesses, and make sure the investments within it are still there for a valid reason.
Each investment you make is another link in the chain of success (we know, how cheesy? but true!)
Don’t allow any weak links.
Arguably the most overlooked factor to consider when investing is how you will be able to handle your emotions. It is so easy to sit here and write ‘keep your emotions in check!’. The reality is that you may not always be able to avoid an emotional response from how the market moves in accordance to your positions, but it is fundamental. You must find a way to do so that works for you personally.
Take one thing from this post above all else. Unless you learn to develop your emotions, there may be severe implications on your portfolio, if you continue making investment decisions out of emotion.
The image below represents a typical emotional rollercoaster that an example investor will be riding during their experience in the markets:
Whilst the above image may be an animated exaggeration, for a lot of investors this is the unfortunate reality that emotions can have on your performance to capture moves and avoid ‘false dawns’ in the market and how emotions can skew your judgement to optimal timing for your portfolios performance.
So how can we relate this back to market pull back or turbulence?
Investors see this huge depreciation in their accounts, they identify that the market has pulled back and can represent great value in some instances. Yet the losses they have seen may have annihilated the investors’ confidence.
Referring back to our emotion chart above, we can see where our example investor should have been buying and then selling. It’s not always so clear-cut whilst this is happening real time and ones emotions are in play.
To be able to sleep at night I recommend having point one of this post down packed and solid first. Make sure that your portfolio matches exactly how your investment criteria and plan outlines it should, that will empower you to know that even when the markets pull back significantly, you should be able to keep your emotions at bay.
Understand that in a portfolio’s lifetime there will be hardships. Having the knowledge that it will take hits but you know how to minimise the overall impact from them, will enable you to act efficiently and prudently. This will hopefully go some way to squashing some of the emotional attachment you may have to the stocks you hold.
We covered emotions in investing in a little more depth here, it’s worth the read!
In short the main aim of diversification is to provide you with the potential to reduce the impact of market volatility on your portfolio. Doing so ensures that the areas of exposure you do have are not going to leave you limping away from the stock market after a bad day, week, month or year.
I often speak to investors who aren’t always quite so hot on the topic of diversification, or perhaps they thought their portfolio was diversified. I also speak to a lot of investors who genuinely understand the topic and are able to talk to us about the upkeep of their existing diversification.
Nonetheless, diversification can be a confusing topic to get your head around, the questions ‘am I doing this right?’, or ‘am I diversified enough?’ are often asked.
Diversification in a pull back
When you’re properly diversified in this scenario, you have more stability and reassurance that your portfolio could have at least one area of investment appreciating in value.
Another sector specific example that is relevant to the events we saw on Monday, is mining companies. Historically the miners have been generous with their dividends as well as seeing strong capital appreciation; these are usually attractive features to investors.
However, since China has been struggling to meet demand, oil prices have lost roughly two-thirds of its value and more recent disappointment stemming from knowledge that Beijing have not announced expected policy support, the miners have been impacted negatively.
Some investors may have bought in to the sector and loaded up their portfolios with miners at a reduced price.
Why? They had the emotional optimism that the sector would turn around, or reach where they once were in value, without considering the bigger picture, or China’s impact.
This overexposure combined with the recent events has meant that a lot of investors may have struggled. Measures to ensure protection (diversification), were not even considered.
So what does it mean to have a diversified portfolio?
It’s difficult to point to the exact parameters for diversification; we have covered the topic in much greater depth here. As a very quick and simple understanding, diversification can take the shape of investing across separate asset classes, eg. Bond purchase alongside equity purchase.
The premise that if you have different asset classes in your portfolio in a crisis, there is a greater chance that something could be offsetting any losses you are experiencing in one area of the portfolio, or at the very least offering some protection in a difficult period.
The point is to determine what sort of decline you can experience and survive in advance, and not to invest predominantly in one area of the market that will make you lose sleep if it is hit.
There are many ways in which you can handle a significant market pullback. Events like ’Black Monday’ aren’t regular occurrences, but the fact it has happened before makes it fair to suggest it can happen again in the future.
Whilst many investors may be licking their wounds from Monday’s events, the proactive (and those who have a solid structure and set of rules) will be re-aligning themselves to weather the next challenging event!
I hope I have got the message across on how intertwined each of these points are, each will have an impact on the other and collectively all three need to be in place to build an overall successful portfolio.
If I can, I would love to help you work out your own means to achieve each of the three points above.
As ever in time of crisis it helps having someone who you can talk to and more importantly rely on, so why not just get in touch with me and see if I can help at all?
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Wayne is Co-Founder & Director of CSS Investments and has worked in the City of London for almost 25 years.