Is it safe to get back in the water?

When we experience a major fall in financial markets, it is perfectly reasonable to wonder if this offers an attractive opportunity to place additional new capital.  However, it is worth remembering that just because a stock has fallen by 40% or 50% does not mean it cannot fall by another 50%, so there is no simple answer and great care is still required.

Investment markets usually ‘over correct’ on both the downside as well as the upside and if it were possible to know for certain when they had hit the bottom, it would very profitable to invest at that point.  However, if everyone knew that, they would all want to do it and the prices would go up very quickly.  Personal judgement of where the bottom is will vary, and we will only know it for sure some time after it has been reached.

Individual approaches to investment risk will also play a big part in when to enter the market.  It is true that the best market returns are achieved in the period immediately after a major sell off but it takes strong nerves to buy before signs of a genuine sustainable recovery emerge.  Investment horizons also play a part in the decision of when to enter the market. A longer-term investor may be able to live with a further short term fall, in the expectation that they will receive a positive return in two or three years’ time, rather than wait until the markets have recovered therefore missing out on benefits offered by the recovery, when it comes.

For anyone wishing to take advantage of current market levels to place new investments, but wanted to take a cautious approach to protect against any further falls, there are two routes they could consider.  The first would be to utilise the principle of price averaging and the second would be to place an investment in a structured investment plan.

The principle of price averaging acknowledges that we cannot be certain the markets have bottomed out so further falls are possible, but we do not want to miss out on the recovery.  Rather than take the risk of placing all the capital at one time and see it fall in value, if company reports over the next few months prove to be less optimistic than current market assumptions, the investments are placed at regular intervals to average out the prices paid.  Admittedly this method means that it will never achieve the maximum return that could have been obtained if the investor had correctly identified the bottom of the market.  However, it does dramatically reduce the risk of mistiming the recovery, so if that option appeals, the plan would be to develop a portfolio of funds likely to benefit when recovery starts.

The other alternative is to place the investment in a Structured Investment Plan.  The concept of this type of plan is that they are set up for an agreed number of years, but with the possibility of maturing early if market conditions are met.  Meanwhile, fluctuations in market values are of no concern as the capital is protected, provided the index it is linked to is no lower than a set percentage of the starting level (typically 60%).  Current anticipated returns are between 9% and 10%, depending upon how the plan is structured, with the capital and returns repaid on the anniversary date as long as the market index is at least equal to the starting level.  It is even possible to find a plan that could return the capital and returns, even if the index had fallen by up to 15% of the starting level.  At current index levels, such a plan could offer an interesting way to benefit from the fall in market values, but there are many different varieties of these schemes and detailed advice is very important to ensure that any particular plan is appropriate for your circumstances.

There is no doubt that the economy is in for a difficult few months and there are still risks of further falls in the value of investments, but markets try to anticipate the position in the future and for anyone prepared to look through the current situation,  current prices could offer good value over the next two or three years.  Please remember that past performance is not a guide to future performance.

In summary, it is safe to get back in the water, provided you are aware there are still Great White Sharks out there in the distance, so caution and well researched advice will be critical.

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