The months of steady stock market growth seem to have come to an abrupt end, with hundreds of points wiped off share values since in the early part of last week.
It’s not just the London based FTSE that has fallen. The Dow Jones registered its biggest ever one day loss. Stock markets around the world are in the red. But it doesn’t mean that the global recovery is over, or that it’s time to sell. In fact, it is still perfectly possible to invest for growth.
What has happened to the recovery?
The recovery is, as far as anyone can tell, still going on. What has happened to the markets may be nothing more than a correction, the result of markets being overheated.
Of course, the size of the correction has taken many by surprise, but there were those who believed that it was overdue after massive rallies in January. A correction is simply part of the volatility that is inevitable with stock markets.
It looks as though the falls were triggered by the threat of inflation and potentially higher interest rates, particularly in the US. Wages in the US seem to be growing at their fastest in more than eight years, according to last Friday’s payroll reports*, fuelling expectation that both inflation and interest would rise more than forecast.
This means that the markets operated as check on the economy. Falling indexes can be a small price to pay if inflationary pressures are reduced.
What does this mean to your money?
A FTSE that shows the healthy green of growth is of course a sign that our equity holdings are growing in value. Even if we don’t hold equities directly, it means that our pension pots and the broader economy are heading in the right direction.
But volatility in markets, and even a fall in value is really nothing to worry about. The markets always have and always will fluctuate, but the overall trend is for equities to generate wealth.
There may be an instinct to sell when the market falls, to avoid further loss, but for most people, hanging on to equity holdings may be the best course. Selling will simply crystalize the losses and mean missing out on the profits if prices rise. Professional investors may even seize on falls as the key time to buy.
What should you do?
It is always important to be prepared for falls as well as rises when you invest, but there are some proven principles that can help make investing relatively worry free.
The first is to recognise that investing is for the medium to long term. Short term, falls can mean losses. Over a few years, the market should deliver growth.
Second, you need to understand the level of risk you want to deal with. In your twenties you can afford to invest speculatively and buy those holdings where a greater risk of loss is compensated for by a greater chance of growth. As time goes by you can adopt a more conservative risk profile, aiming to secure the profits made in previous years.
This is known as asset allocation, and a key principle for successful investing. You may need to regularly rebalance your portfolio to keep it aligned to your changing outlook.
Another key technique is Pound Cost Averaging. This simply means investing a regular amount, usually in a shared fund. When prices fall, your investment buys more units – and when they rise, although your investment buys less units, your total holdings should increase in value.
The value of investments can fall as well as rise. You may get back less than you invested.
Bureau of Labour Statistics – Employment Situation Summary – Feb 2018*