When the share market is rising, investing seems easy. It’s a different story, however, when the market is thrown into panic mode, as it has been since Friday. All of a sudden investing seems a lot more challenging.
Following a basic set of rules is paramount to long-term investing success and can help navigate the landscape during turbulent periods. Here are four key rules that I’ve been reminded of during the recent Brexit volatility.
Diversify properly
Diversification is a simple concept yet one that’s easy to neglect. When building a portfolio, it’s important to ensure the portfolio is diversified at both an asset allocation level and also at stock level.
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At asset allocation level your portfolio shouldn’t be exposed to any one asset class. Unfortunately, many investors often suffer from ‘home bias’ whereby they invest primarily in domestic equities, ignoring the diversification benefits of having international exposure.
This can backfire in the event of a domestic downturn and investors with a high proportion of their portfolio in UK stocks will certainly be feeling the pain this week.
Furthermore, at stock level, ensure your portfolio is properly diversified and not overexposed to specific stocks. No matter how much you like a particular stock, always consider the downside risk.
Also, having a few ‘defensive’ stocks in your portfolio can provide a buffer in uncertain times. Stocks like Unilever, British American Tobacco and Diageo have outperformed the market since the Brexit vote results.
The power of dividends
Numerous studies have shown that dividends contribute a large part of total returns over the long term. For example, over the last five years the FTSE 100 has returned around 8% before dividends. Add-in reinvestment of the dividends and the return is closer to 30%, a huge difference.
For that reason I’ve adjusted my investing strategy over the years to focus more on dividends. While no one likes seeing the capital values of their investments fall, there’s no doubt that dividends provide a certain level of comfort during volatile times.
As a long-term investor, the capital values of my investments aren’t that important in the short term. What’s more important is that I receive regular dividend cheques from the likes of Aviva, Legal & General and BAE Systems and that I reinvest these dividends back into the market.
Don’t be overexposed
It can be easy to get greedy during the good times. But being greedy can lead to a huge risk, overexposure. I’ve learnt this lesson the hard way before. It’s important to ensure that you’re not over exposed to the share market.
Make no mistake, the market can be extremely volatile and can hit the hardest when you least expect it. So only invest what you can afford to lose. If you’re likely to need the funds in the short term for a house deposit or university fees, the share market is most likely not the best vehicle for your savings.
Stockpile cash
Lastly, it always pays to have some cash on the sidelines ready to deploy when opportunities arise. With many stocks having fallen 30% to 50% in the last few days and market volatility likely to persist, there’s no doubt that opportunities will arise at some stage.
Having cash available allows you to act on these opportunities.
