The FTSE 100 has along with other world stock markets seen large falls over the past few days, dropping at one point today to its lowest level for eight months.
The falls have been caused by fears over the mounting debt of ‘Eurozone’ countries with concern growing that governments and central banks have not done enough to ease the problem. The IMF (International Monetary Fund) suggested at the weekend that the Spanish economy needed comprehensive reform and the rescue of Spanish bank Cajasur at the weekend caused further nervousness.
Why does the Spanish economy affect prices in the UK you ask? Well, in an era of unprecedented globalisation the price of shares are linked as never before to the economies of the world, the worry is that the European debt situation will stall the worldwide economic recovery and then have a knock on effect to corporate earnings and company profits.
Add in the political tension between North and South Korea and the ban by the German government on certain types of short selling and you have a return to the volatility of the past couple of years.
So, as an investor how should you react to the recent return to volatility? Ride it out or cash everything in now and head for the hills? Here we try to offer you some practical ideas of things that you can do during this difficult time:
If you have any money invested in stocks and shares, either directly or through funds, then the chances are the value of these holdings have fallen over the past few days. Whilst the idea of investing is for the value to rise you are always going to see volatility in equity markets and this is part of the risk versus reward equation.
There are two things that you need to do. Firstly, take a look at your investments, as painful as this may be, to see how much damage has been done, the value is what it is, but you never know the damage may not be as bad as you had feared.
Once you have seen the valuation, think back and remember why you made the investment in the first place, the chances are it was for the long term, perhaps to plan for retirement, to beat the low interest rates that are currently being paid, or for some capital expenditure that you have planned. As painful as any short term losses are, remember that if you sell the investments now you will ‘crystallise’ your loss. Selling after a period of losses is rarely the right thing to do, those that are patient tend to be rewarded and if equities match your attitude to risk, moving out of them after a fall means that you may well miss any future rise.
However, what if you need the money from your investments, for example to provide an income as you are retiring? This is an all together harder question to answer. Consider taking money from investments that have not been held in equities such as property, corporate bond or gilt funds, these may not have been hit so hard in the past few days, also think about taking money from deposit based savings where the interest rate may not be competitive. Consider, if you can, putting off that purchase or retirement until things are a little less volatile.
Secondly, and assuming you make the decision to sit tight and not sell, there are other steps you should take with an eye to the longer term.
Start by reviewing the asset allocation of your portfolio, looking at how much exposure you have to equities and other asset classes such as gilts, commercial property, and corporate bonds. As a very general rule of thumb the more risk you are prepared to take the more you should have invested in equities and vice versa. Asset allocation is one of the keys not only to performance but also to ensuring that your investments match your attitude to risk.
You should also ensure that money you need in the relatively short term is held in cash so that you are not caught short by falls in the stock market in the future. This rule equally applies to money held in pension funds in the years up to the point when you will want to take an income from the fund.
When you have reviewed your asset allocation consider the funds you hold, many funds regularly underperform and these should be ruthlessly dropped from a portfolio and replaced. Continuing to have blind faith in a fund that regularly outperforms is rarely rewarded.
Finally, review the tax wrapper in which you hold your investments, whilst not directly linked to performance of your investment it does have an impact on the value of it. Make sure you utilise your annual ISA allowance and consider investing in other tax efficient vehicles where appropriate such as pensions, certain National Savings products and also making sure you use all your tax allowances to their fullest extent.
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