Do you need to worry about a stock market crash?
If you regularly read any of the mainstream news media, it’s been hard to escape this month: it’s been ten years since investment banking giant Lehman Brothers went bust.
That sent shockwaves around the financial world, aggravating an already serious credit crisis, tipping global shares into a perilous tailspin and subsequently sending first-world economies into serious recessions. Pretty sombre stuff.
That, together with all the talk of the longest Wall Street bull market in history, has led to speculation among investors and in the media as to whether we are due a stock market crash again.
It can certainly make you think twice about putting money in the stock market. So how much does someone who is thinking of getting into investing have to worry - and what can they do about it?
The first thing to note is that crashes don’t come along on a regular basis, and even when they do, the damage to the market long term may not be as bad as it first seems. There was a major crash in 1987, but look at a long-term chart of the FTSE 100, the leading London stock market index, and you will see a general rising trend from the early 1980s until 1999.
It then went on a downward trajectory until the end of 2002, rose until autumn 2007, fell dramatically until March 2009 and then, with a couple of significant corrections, has been broadly on an upward trajectory.
But we are currently well below the all-time peaks set earlier this year when the FTSE 100 index hit 7,850 – a doubling of its level at the end of the financial crisis in February 2009.
Some think that because of a few significant corrections – or mini-crashes – in the ten years since Lehman, a big crash is now less likely. Which brings us on to the next and most important point… that it is pointless to try and time the market – particularly for inexperienced investors.
How time is on our side
Investing is for the long term, and one very important thing that young investors have on their side is time. So if we start investing today and the stock market crashes next year, as long as we don’t want our money back immediately, it may not bother us too much. Markets constantly fluctuate and there is always a risk with investing that we may not get back the amounts originally invested.
If someone knows that they need to cash in their investments at a certain point, they certainly need to take steps as they approach that time to defend against a crash. But if you’re not going to touch your investments for 10, 20 or 30 years then, assuming you have chosen carefully what to invest in, you can leave them to do their thing.
Which brings us to the third point: your attitude to risk and what you can do to help limit the effects of market volatility - as this will determine what you invest in.
What is your attitude to risk?
Financial advisers may encourage young investors to put a higher proportion of their portfolio (or their pension pot) into riskier assets that have high long-term growth prospects – perhaps global equities with some emerging markets exposure.
But how much of that you want will be governed by your attitude to risk and your own personal circumstances. And some people don’t like too much risk. Here are some tips that could potentially help limit negative effects of corrections and crashes on your portfolio or pension fund.
Food for thought on the effects of corrections and crashes on your investments:
Drip-feed investing: in other words, invest a regular amount each month. This means you are buying into the market at all sorts of different levels: when equities or funds are expensive you will buy fewer units; when they are cheaper, more. By spreading your entries into the market over time you are reducing the impact of volatility and crashes. If you have a lump sum to invest, depending on its size, you might want to take financial advice. Either way, the considerations are likely to be along the lines of the next three tips.
Diversification: the more risk-averse investor will want to hold a lower proportion of his or her savings in equities and more in less volatile (but also often less rewarding) assets like bank deposits, government bonds and property.
Active or managed funds: these investments are managed by specialists who try to “beat the market”, as opposed to passive funds or trackers which simply follow the market. Some can be very adventurous but many are defensive. “Multi-asset” funds offer you immediate diversification by investing across a mix of asset classes. It comes at a cost, as active funds tend to have higher fees.
Target high-yielding investments: some company shares pay good dividends and some funds target those investments, offering “high income” with the possibility of greater stability. There is no guarantee they will meet these aims though.
The value of investments and the income from them may go down as well as up and you may not get back the amounts originally invested. As ever, talk to a financial adviser or planner who can help with your particular situation and attitude to risk.
Read more: Is investing for me?