How to survive the crunch

PUBLISHED: 11:16 10 July 2009 | UPDATED: 08:56 21 February 2013

Financial expert Simon Michael starts a series of articles on ways to weather the economic storm with advice on investments

Financial expert Simon Michael starts a series of articles on ways to weather the economic storm with advice on investments

For the average investor, this has proved to be a very eventful year. Following the collapse of the US sub-prime mortgage market, we have been hit by an increasingly prolonged credit crunch, the nationalisation of a UK bank, the take over of a major investment bank and now sweeping changes in the US to support two of its largest lenders. Speculation about the possible severity of the fallout continues to dominate headlines and talk of economic slowdown, coupled with soaring food and energy bills, have only compounded the pervading atmosphere of nervousness.
For companies, the credit crunch has led to a sharp increase in the cost of borrowing. Although many companies are in decent financial shape, some - particularly smaller companies - are finding tighter credit conditions hard. This could ultimately lead to job losses and higher unemployment.
On the consumer side, what was a booming housing market fuelled confidence, giving UK homeowners (in hindsight) an over-inflated sense of wealth. This, coupled with the availability of easy credit, encouraged many to borrow large sums of money. However, the collapse of the sub-prime mortgage market has severely cut access to easy credit and house prices are now falling. Consumers are more wary about their spending and many UK retailers are suffering as the environment proves difficult.
This has sent a worrying signal to those already concerned about economic growth and sentiment among equity investors has taken a knock, reflected by the volatility now evident in the FTSE 100 Index. There are still some investment winners to be found but selectivity and setting realistic expectations are key.
Looking ahead, investor sentiment remains fragile and bad news continues to cause disproportionate levels of response. Investors have good reason to be wary in the short term; however, stock markets tend to be driven in the short term not by logic, but by emotional factors such as fear (and greed): the key is therefore to stay calm, think long-term, and be selective. Astute long-term investors should remain objective and remember that, in the words of Franklin D Roosevelt, "the only thing we have to fear is fear itself".
So, with this in mind what is the most useful tool that a successful investor could have? Strong research? Access to company management? A prodigious memory? These are all useful - perhaps even vital - attributes. However, the most useful tool is the one thing that nobody can have: the benefit of hindsight.
As long experience shows us, different asset classes and industry sectors will provide strong or weak performance at different times. For example, equities are widely acknowledged to have provided the best long term performance of the four main asset classes - but most investors who lived through the meltdown of the dot-com sector know only too well that short term, things can be quite different. Bonds on the other hand, are viewed as medium to lower-risk investments, particularly when economic growth is on the wane - but last year's developments in credit markets left many with burnt fingers. Meanwhile, in times of uncertainty, investors make tracks for the safe haven of cash - but leave your money there too long and the value can fall prey to the corrosive effects of inflation.
The theory runs like this: during periods of strong economic growth, equities are likely to perform well, whereas when economic growth is in decline, bonds and cash should prove more beneficial. 'Specialist' asset classes - such as commodities and property - are also available and can perform differently from all of the above. (However, do note: these need expert advice and should be approached with a modicum of caution).
What can be tempting for investors is to chase the best returns by jumping from one asset class to the next when it looks like the returns are promising. However, in reality this rarely works. If judging the right time to switch and where to switch to were easy, we would all be rich. Even some of the full-time, so called professionals consistently get these decisions wrong. Therefore, instead of trying to choose which asset class to be in and when, perhaps it would be better to have a bit in all the asset classes, all of the time.
This is called diversification - the act of spreading your investment across more than one asset class. In doing so, you not only make sure you are invested in the asset class which is performing best, you also ensure you are not 100per cent invested in the asset class which is doing worst. Instead you get a bit of everything - and as a result, your investment returns should be smoothed out as performance rotates through the asset classes and each compensates for another as time goes by.

If you require further information contact me on 01743 285777, email mail@mardons.co.uk or visit www.mardons.co.uk
Simon Michael MIFP AFPC,
Managing Director,
Mardon Financial Advisers Ltd,
Shrewsbury.

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