A financial storm has seen shares plunge around the world and many investors fear a rerun of 2008’s crash.
Western economies on both sides of the Atlantic are looking rudderless and emerging markets are grappling with the need to raise rates to combat inflation at the same time as the world economy stutters.
Investors have been left wondering whether they should bail out of the market, or whether this is a buying opportunity not to be missed.
We take a look at what you can do when uncertainty is the name of the game, how to protect yourself from the market’s storms and how to separate the buying opportunities from the traps.
Here are 10 questions investors should ask themselves.
Am I being panicked?
Investing is meant to be a long-term game and a part of that game is that slumps hit, and when they do they hit hard and arrive fast. Trying to time the market and bail out whenever you see stormy waters is very difficult. In fact, it is something that is beyond most professional fund managers and can seriously dent an individual investors’ portfolio.
(Those who want to turn a short-term profit from riding the market up and down are traders not investors and they play high risk strategies where different rules apply.)
Investors who make serious money over time, such as the Warren Buffett's of this world, have a long-term outlook and expect peaks and troughs along the way.
This does not mean that you should just sit immobile and buy and hold forever. The way to make money is to buy low and sell high and knowing when to bow out is crucial, but frantically bailing in and out of positions as the market rises and falls is likely to soon lead to your investment cash vanishing.
As the turmoil arrived, Tom Stevenson, investment director, at Fidelity International, said: ‘For investors, this kind of volatility is an unwelcome reminder of the market’s rollercoaster in the autumn of 2008 and a severe test of their ability to keep their heads while others are losing theirs; to focus on long-term investment goals and remain calm.’
Am I about to make rash decisions?
Remember that times when you have just lost money or feel you have missed out on an opportunity are those when you are most vulnerable and likely to make a rash decision.
If you are bailing out of a market because of fear then cash is likely to be the best place to wait out the storm – not a punt on a different share that has tumbled and you think can bounce back.
If you put money in equities, be it in individual shares or a fund, you should be thinking in periods of five years or more and identifying what you think will be a solid performer over that period.
A stock market slump always contains traps. Markets typically sustain big falls and then steady or stage something of a rally. At this point investors are often regaled with talk of buying opportunities and start considering shares, markets or funds that they think could bounce back.
Be very careful at these times and only invest sums that you can afford to take a hit on if markets start falling again.
Are my investments still any good?
Tough times are when fund managers earn their salt. Investments come in two forms active, those that are managed and aim to beat the market, and passive, those like ETFs and trackers than rise and fall with an index.
Theoretically when the bad times hit, active investments should do better – after all you are benefiting from the manager’s years of expertise. This is not always the case, however, and if you feel that some of your money is in fund that is too high risk for you, or there has been the nagging suspicion that the fund manager is not worth their hefty fee, then a stormy market can be a good prompt to reconsider your investments.
If you do make the decision to sell up, then consider your positions carefully. The key is not to believe you can call the top and the bottom, but to evaluate whether an investment has served its purpose for you and whether you still believe in that company, fund or asset. A good question to ask is whether disregarding the market storm this investment still has the potential to deliver over the next three to five years?
Have I got the right idea but at the wrong time?
Other good points to consider are whether your investment is the right idea but at the wrong time and whether you are too heavily invested in one area.
Rebalancing a portfolio is something that the best fund managers do regularly and individual investors should also consider doing this.
Bruce Stout, manager of Murray International investment trust, says: 'Stock markets both in developed and emerging countries are likely to remain volatile. But fundamentally some companies are in good shape with strong balance sheets and business models able to weather the current environment.
‘These sorts of companies are not exclusive to a particular sector or region but they do share three common attributes - low debt, exposure to growth markets and a commitment to paying a growing dividend. The last attribute is of particular importance given the low interest rates available on savings accounts.'
Should I use regular investing rather than put in a lump sum?
A study by the Association of Investment Companies showed that in the last bear market, of September 2007 to February 2009 a £50 regular monthly investor into the average investment trust would have lost 33%, while the equivalent lump sum investor would have lost 44%.
Crucially, if regular investors had continued putting £50 per month in to the end of 2009, losses would have turned into a 9% gain, whereas lump sum investors would still be nursing a 16% loss.
In the previous bear market from February 2000 to October 2002, a regular investor would have lost 30%, while a lump sum investor would have lost 37%.
Over the longer term, lump sum investing has outperformed, however. In the 10 years to the end of June, a £50 per month investment would have reached £10,057, whereas a £6,000 would have reached £11,855.
Annabel Brodie-Smith, of the AIC, says: ‘Regular investing each month gives you a lower risk profile by helping to smooth out some of the stomach churning highs and lows in the price of shares.
‘Known as ‘pound cost averaging’, it means investors buy less shares when prices are high and more when prices are low and do not have to worry about deciding when the best time to invest is.
‘However, over the longer-term, lump sum investing has outperformed regular investing because investors’ money has been invested for longer, benefiting from the stock market’s gains.’
Are my investments too aggressive?
In times of turmoil, investors may want to consider buying into more defensive shares and funds that suffer less from market volatility. Utility companies, pharmaceuticals, tobacco producers and food makers are examples of defensive sectors because consumers will use these goods regardless of market conditions.
By contrast, miners, retailers and banks get walloped by bouts of prolonged bad news and market slumps.
Many defensive stocks lag the market and do not rise as much in the boom times - certainly it has been higher risk investments that have bounced the most since the recent lows for the markets seen in 2009.
However, on difficult days good quality, defensive, dividend paying investments should protect your capital and deliver good dividends.
Neil Woodford, one of Britain’s most successful investors and manager of the Invesco Perpetual income fund says: ‘We believe the most attractive valuation opportunities exist in companies that are best placed to navigate the economic headwinds and the on-going fallout from the banking crisis.
‘The most dependable, resilient businesses in the market are currently trading on ludicrously cheap valuations, despite their proven ability to sustain and grow dividends. These areas include pharmaceuticals, tobacco and telecoms.’
Should I join the flight to quality?
A factor those brave enough to invest right now might want to consider is that there has already been a change of mood in the investing outlook and a groundswell of opinion has moved behind high grade dividend investments.
This could see a flow of money into defensive shares and funds as individual and institutional investors move away from riskier assets.
Stock brokers reported last week that investors were targeting high-yield stocks on low valuations. Nick Raynor, investment adviser at The Share Centre said: ’Investors are looking at quality FTSE 100 companies who are now sitting on impressive yields. Aviva is offering well over 7% and Vodafone has over 5% on the table at current prices.’
Adrian Frost, manager of the Artemis Income fund, which delivered a 20% total return, including a 4.3% dividend yield in the year to July, has forecast a flow of money into income funds in the next few years.
He says: ‘If you are going to get paid nothing on cash and nothing on government bonds for the next five years then income and global income looks good.’
How defensive should I be?
Typically investors who want to adopt a defensive strategy have been advised to have half or less of their portfolio in shares based investments, with the rest made of cash and less volatile assets such as high quality corporate bonds, gilts and property.
If the market takes off you won’t get the full benefit of the rise, but you should be more protected from falls.
A counter-point to this strategy is that a big question mark hangs over property at the moment and the yield on ten-year UK gilts is currently less than the 3% available on an instant access savings account.
This has prompted commentators to suggest that robust dividend stocks and top investment grade corporate bonds are a good safe haven option at the moment.
Alec Letchfield, manager of HSBC’s UK Focus fund, says that many companies currently have strong balance sheets and are in a much better position than they were in 2008, which should see carefully picked investments weather the storm.
He says: ‘The public sector and consumer are in a disastrous position and have run their balance sheets poorly. Corporates hit the recession hard and now sit there in quite a robust strong position.’
What about gold or cash?
Gold has been another valuable safe haven for investors and is increasingly being sought out for protection from market storms and inflation, however, with bullion trading at all-time highs it is vulnerable to a sell off and investors must be aware that it is not low risk.
Stephen Barber, an economic adviser to broker Selftrade, says: ‘While gold remains a comforting refuge, a seemingly safe store of wealth, investors should exercise caution here also. While prices might well continue to rise, there is evidence of an asset bubble in gold which could easily burst as conditions change.'
Cash is the absolute safest haven for those wanting to avoid risk altogether, and can be deployed to pick up cheap assets when you think that it is time to buy back in.
If you are extremely nervous about the state of the stock market, then it is worth considering selling up, taking profits and putting your money into a savings account. This is especially true if you feel that you cannot afford to lose the money that you have invested. In that instance, you would be better off in cash where your money is protected.
Brian Dennehy, who runs financial planner Dennehy Weller & Co, says: 'If you have been shocked by the past few weeks, there is no embarrassment in admitting that investing in risky assets is not for you.' You can plan to make an orderly exit when markets start to recover.'
How do I separate an opportunity from an investing trap?
The most successful investors see slumps as an opportunity to make money. Investing guru Warren Buffett has revealed that his company has been buying as the market falls. 'I like buying on sale,' he said.
Buffett famously bought a $5bn stake in investment bank Goldman Sachs when no one would touch it, turned a 30% profit and even negotiated preference shares that paid him a 10% annual return.
In another famous investing take of recent years, UK hedge fund manager Crispin Odey went short on bank shares and took a punt on them falling heavily as the financial crisis hit, before then adopting the opposite strategy and betting on them rising as governments propped up the sector.
Investors dream of making that kind of big conviction investment and most can recount a few they wish they had backed. But making moves like these are a gamble and that means that you should only assign a small proportion of your capital to them, otherwise if your punt backfires it will have disastrous consequences.
Not everyone can spot the great recovery story and the investing world is littered with those who thought they had spotted a prime candidate for bouncing back that just kept falling – the cliché is that it is like trying to catch a falling knife.
If you do think you have spotted an opportunity, ask yourself two simple questions to make sure it isn’t a trap:
1) Am I investing just because I feel I should do something rather than nothing?
2) Would I invest in this fund or firm under normal circumstances?