The implications for investors of the result of the UK referendum on EU membership will be played out over the months ahead and it is very likely that volatility will persist in the near term. Although we understand investors’ concerns, you should not need to make dramatic changes, provided you have a well-diversified portfolio.
Financial risk needs a different reaction
Human evolution has made us instinctively averse to uncertainty and this is especially true in the financial markets, according to Professor Andrew Lo of MIT’s Sloane School of Management. Dr Lo has said that our natural reaction to physical risk – what has been described as ‘fight or flight’ – may save our lives, but that the same reaction to financial markets tends to make us short-term investors and so miss out on the benefits that long-term investing can bring.
UK investors who moved into cash ahead of the Brexit results on 24 June will have seen the FTSE100 make a remarkable and unexpected climb of around 6% in the following month, leaving them well out of pocket. From a historical perspective we can see the dangers of moving out of the markets when the outlook seemed bleak. Investors who moved into cash in March 2003 or March 2009 risked missing out on a double digit rise in the FTSE100 within the following few months.
Duller growth is likely
The UK economy will be impacted by Brexit and uncertainty as to how this will show itself will prevail for some time. Cazenove Capital’s Chief Investment Officer, Richard Jeffrey, has said “Whatever the long term may bring for the UK, it is hard not to conclude the UK economy will see duller growth for a couple of years, though quantifying ‘duller’ is impossible at the moment.”
Is there a safe haven?
For some investors the solution will be to leave their money in cash, but as we have seen this has dangers as markets can move upwards very quickly. Inflation will also reduce the buying power of your capital over time. Many investors have been lured by the so called ‘safe haven’ of gold as the price spiked following Brexit. But gold has its risks too and its value in the first quarter of 2016 was down on three years ago.
The best solution for investors
The answer to unexpected events like the Brexit result and the subsequent ups and downs of stock markets is to invest for the long term and to diversify. Investing for the long term means not panicking and bailing out when investments fall. And diversifying means spreading your investments – not putting all your investment eggs in one basket.
Diversification will help protect your investments from the full impact of the volatility of the UK stock market. What’s more, with the pound falling against other currencies, it means that your overseas investments produce an additional benefit for you when they are converted into sterling.
Your investments should not just consist of equities – that is share based investments. Lower risk portfolios may have a quarter or more of the portfolio made up of fixed interest investments. It is often the case that when shares fall, as they did immediately after the Brexit vote, bonds – especially government bonds like gilts – rise in value. It doesn’t always happen like that, although bonds tend to be less volatile than shares.
Most people’s instinctive reaction to any kind of danger is often flight. But as we’ve seen, that could be an expensive mistake.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.