By ADRIAN LOWCOCK 04/08/2009
During the latter half of 2008 and the first half of this year, we have seen fear stalk the stock markets. For many investors, it felt like they were standing at the precipice staring into the abyss. In the last six months, things have turned around significantly; markets have rallied from their current lows, banks are posting positive earnings and financial armageddon has been averted. For most, the change in sentiment has been swift and there is a feeling of being left behind.
It is easy to look back in hindsight and realise when the bottom of the market was. However, at the time the perceived risk of investing and fear of losing more money was just too great for many people to dip their toe back into the water. Now, as the market rally continues, investors fear that they have missed the opportunity to get in at the bottom. The further it goes up, the greater the fear gets, until it causes an over-reaction and investors buy excessively into the market.
Over-reaction
The consequence of investors putting too much emphasis on recent news, at the expense of other data, is market over- or under-reaction. Individuals show overconfidence; they tend to become more optimistic when the market goes up and more pessimistic when the market goes down. Hence, prices fall too much on bad news and rise too much on good news. In certain circumstances, this can lead to extreme events and ultimately investors end up doing the reverse of what is best investment practice by selling low and buying high.
What you can do
There are very experienced fund managers sitting on both sides of the fence at the moment. With the equity markets having risen from their lows, it is now more difficult to view where they may go from here. As an investor, there are a few things you can do to avoid getting caught out:
- Get a plan - You should have your financial objectives set out as these will help you determine the suitability of an investment and focus on the end goal, not short term volatility
- Save monthly - Drip feeding money into the market will mean that you can take advantage of any market falls, but also you will not get left behind if the market continues to move upwards.
- Diversify - Whilst equities are catching all the headlines other asset classes are also worth investing in as the relative merits of each asset class will vary as the economy recovers. For example, commercial property or corporate bonds both offer attractive returns at present.
Asset allocation
You can even out returns and reduce your level of risk by combining different types of investments in a portfolio (e.g. bonds and equities). Asset allocation sits at the heart of Bestinvest's approach to investing as it can account for over 90% of returns.
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