Have markets already bottomed or will the recent rally prove to be a false dawn? We can all take a side in this debate, but the fact remains that no one knows for sure.
This is why I think the most rational approach in the current climate is to focus on maximising the chances of achieving a great result rather than stretching for an exceptional one. Here are three smart investing moves that fit well with this mentality.
1. Drip-feed
The desire to buy at the very bottom and sell at the very top is natural. In reality, it’s very hard (if not impossible) to consistently do so. This is partly because no one rings a bell to announce market extremes.
There’s also a human element to this. When markets crash, fear abounds. Most people worry that they’ll fall further. When markets then rally, greed takes over. A lot of us assume we’re in danger of missing the boat and dive in headfirst. And then they fall again.
Enter ‘pound-cost averaging’, otherwise known as drip-feeding your money into the market. Simply set up an instruction with your broker to invest the same amount of cash into a fund or stock on a monthly basis.
By following this process, you remove emotion from the equation. You also help smooth out returns by (automatically) buying more when prices are down and less when prices are up. It saves a lot on commission too!
2. Diversify
Gradually moving your cash into stocks is all well and good, but it will count for very little if your portfolio isn’t sufficiently diversified. Having the vast majority of your wealth in oil stocks, for example, won’t protect you in the event of a crash in the price of the black stuff (such as we’ve recently experienced). Holding only small-cap stocks can be a recipe for a disaster in tough economic times as many of these might fail.
This is why holding a combination of nimble minnows. solid mid-caps and established blue-chip stocks in a variety of sectors is smart for most people.
Of course, diversification can extend beyond stocks. Having a balanced portfolio containing some exposure to bonds, property and gold can provide protection if/when one or two of these assets perform poorly.
Will this put a cap on returns? Yes, up to a point. Research has shown that keeping all your money in stocks will give you a better return over time compared to spreading it around.
What research can’t do, however, is replicate the emotional rollercoaster inherent in such a strategy. I’d argue that sacrificing some profit for good health is worth it.
3. Defend
A final smart move to make in uncertain times is to gravitate towards those stocks that have proved particularly resilient in previous economic storms.
Within this category, I’d include consumer goods firms, utility companies and big pharma. All three sectors provide goods and services that are always in demand so earnings should remain relatively stable. This also means that many of these companies will continue to pay dividends to their owners at a time when a lot of firms won’t.
The only flipside to the tendency of defensive stocks to hold their value is that they are unlikely to generate the biggest gains as markets recover.
