Why volatile markets favour regular savers
Even before the events of this week, share prices were down due to rising interest rates that are a response to the spiralling cost of living. Higher rates have hurt the fortunes of many of the world’s biggest and – up until recently – best stock market performers.
Markets hit a recent peak at the turn of the year, but it’s been downhill since then. At times like this it’s easy for even experienced investors to get the jitters and look for an exit. That might cut their losses in the short-term, but it’s likely to be a losing strategy in the long-term.
By selling assets that have fallen in value investors will be locking in those losses. By staying invested they have at least the chance that prices will recover, something history suggests they tend to do.
Taking emotion out of decision-making
Periods of extreme uncertainty, as we’re living through right now, are when it makes sense to go back to first principles as an investor. Investing regular monthly amounts is a way to take some of the emotion out of your decision-making. Come rain or shine, you make your contributions automatically and thereby withstand the urge to make hasty calls that you live to regret.
By investing regularly during periods of market falls, your money will buy more assets each month than the month before. In effect you are ‘buying low’ – a key element to long-term investing success.
The technical name for this effect is ‘pound cost averaging’, where you can lower the average cost of each asset you buy by investing regularly through falling markets. If you sell out or cease your regular contributions during these periods you will have taken all the pain but with none of the potential gain.
To make this plan work, of course, you need to be able to stay invested for long enough that your assets have a chance to recover. On this point, history may be on your side. Past performance is never an indication of what will happen in the future, but we do have recent examples to show us how quickly markets can recover to reassure those who stay the course.
For example, almost exactly two years ago investors suffered another period of volatility as Covid-19 rocked markets. Data from Fidelity International shows how investors paid a heavy price in those early weeks of the pandemic, with £1,000 invested at the start of 2020 in the Dow Jones – an index covering the world’s largest stock market in the US – falling in value to just £825.50 by 31 March.
As can often happen in times of market panic, those falls were broad-based with few sectors escaping as investors fled assets they saw as risky. It meant there were many companies that suffered short-term losses despite not particularly being affected by disruption caused by the pandemic. Cooler heads soon emerged and began to show the reality of the situation.
The snap-back in overall market levels was rapid and by 31 August 2021, all the ground lost had been recovered, with the value of that original sum growing back to £1,002.20. It would go on then to reach £1,298 by the end of 2021. Those investing regularly through that period will have seen the assets they bought in the difficult early days of the pandemic recover and perform more strongly overall.
Key to making regular investing work for you is to be able to leave your plans untouched through these difficult periods. Building a store of savings before you invest – between three and six months’ worth of income is recommended – means you won’t have to sell at short notice to get money if you need it. A diverse portfolio of assets will also help to cushion the worst of the falls.
Beyond that, it makes sense to avoid an impulsive reaction to market noise for a while if you can. Difficult times are as much a part of investing as the good times – the trick is to stay the course until better days emerge.
Ed Monk is associate director at Fidelity International