This communication is for informational purposes only and is not intended to constitute, and should not be construed as, investment advice, investment recommendations or investment research. You should seek advice from a professional adviser before embarking on any financial planning activity. Whilst every effort has been made to ensure the information contained in this communication is correct, it is subject to change and we are not responsible for any errors or omissions.
Many people are interested in investing. Yet, a common fear is losing your money in a market “crash”. What is the best way to prepare for a potential bear market? How should you react if one occurs? Below, our financial advisers at Scottsdale offer some reflections.
We hope these insights are useful. If you want to discuss your financial plan with a member of our team, please get in touch to arrange a free, no-obligation financial consultation:
+34 966 460 407
info@scottsdale.eu
How common are stock market crashes?
This is a difficult question to answer. After all, there are different stock markets across the world. The US stock market is different from that in the UK, Europe and Asia. Within each of these regional markets, there are also “sub-markets” which may perform differently.
For instance, a stock market crash in a particular country may not accompany a similar crash in that country’s bond market. One sector – e.g. healthcare – might show high resilience in a particular timeframe, whilst another – like oil and energy – could underperform (as happened during the “Covid Crash” in early 2020).
Market “pullbacks” are more common than many people think. Over the last 20 years, a correction of 10% or more (i.e. markets falling from all-time highs) has occurred in 10 of those years. This is not to say that all “crashes” are the same.
The Great Depression in 1929 was clearly more impactful than, say, the 1962 Kennedy Slide. However, it can put things in perspective to know that pullbacks are fairly common. To invest wisely in markets, individuals need to build a long-term strategy and stick to it.
Time in the markets, not timing the markets
There are two broad philosophies when dealing with market falls. One advocates trying to “time the market”. This involves analysing market trends, huge data sets and other variables to predict when certain stocks (or other assets) might rise or fall in value.
This is the model largely followed by the “active fund management” industry. Here, professional managers pick stocks for their funds on behalf of their investors. Active funds are popular, but they struggle to outperform their “passive” counterparts. One study by S&P Global shows that only 12% of these funds have outperformed the S&P 500 over the last 15 years.
The difficulty with active fund management is that it lends itself to “reactive” investing. When fund managers see their anticipated “winners” fall in their funds, the temptation to sell those stocks becomes very great (leading to crystallised losses).
By contrast, the Second Philosophy for dealing with market crashes is the “Time In The Markets” approach. This acknowledges that it is tremendously difficult – perhaps impossible – to predict the markets accurately and consistently. Rather, investors should simply accept short-term volatility and “ride the markets” as they follow a trend of long-term growth.
This philosophy lends itself to “passive” (or index) funds. These simply follow a market index, such as the FTSE 100 or the S&P 500. No expensive fund manager or research team is required to manage the fund. As such, these funds tend to be cheaper. They are also less reactive to market fluctuations since they simply follow the markets.
Preparing for stock market falls
The first step is to acknowledge that market falls are inevitable. They are built into capital markets. The only way to stand a chance of avoiding them is to save your money in cash. However, cash is a poor asset for growing long-term wealth. Interest rates rarely match inflation, leading to an erosion of spending power over time.
As such, the next step is to carefully consider your attitude to investment risk and volatility. A financial adviser can be helpful here, guiding you through the process of identifying your “investor profile”. A professional will know which questions to focus your mind.
For instance, if your portfolio sudden falls by 25% tomorrow due to a market crash, how would you react? If you are confident that you would stay in the markets, then this might indicate a higher risk tolerance. However, if you know that you would face a strong urge to sell your investments (to avoid further losses), then a more “cautious” strategy may be needed.
In short, the best way to react to a market fall is to stay true to your long-term strategy. Avoid “tinkering” with your investments to try and time the markets. Try not to watch portfolio’s performance in real-time, which can lead to anxiety and impulsive decisions.
If you become concerned about the direction your investments are taking, speak with your financial adviser to get an informed second opinion. Remember the long-term goals you set for yourself and remember that you acknowledged that market falls would occur when you build your portfolio in the first place.
Invitation
If you are interested in discussing your own financial plan or inheritance tax strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
+34 966 460 407
info@scottsdale.eu