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How to invest when markets are high

How to invest when markets are high

A number of investors, including some of our readers, are understandably worried about piling money into equity markets when they are at all-time highs. "I am about to receive a large sum which I propose to invest in a portfolio of funds but am now wondering if it is a good time to invest, when the FTSE 100 is at an all-time high," says one reader. "Should I hold off and wait for markets to fall?"

Another says: "I know that it is 'time in the market' that counts and not 'timing the market', but I believe there is merit in both, and would hate to be the person that invested at the highs."

Both the UK and US stock markets have notched up a string of record highs in 2017 and are looking expensive. The thought of buying assets when prices are highest, and potentially suffering a loss if a correction occurs, is scary. But if you have a long enough investment horizon, you will make money over the long term, even if markets do crash in the short to medium term.

And the prospect of holding your money in cash when inflation is running at a four-year high of 2.9 per cent is arguably even scarier than a short-term pullback.

"Market levels are a valid concern, however if you are investing over five, 10 or more years you will make money, but have to accept that there will be peaks and troughs in the meantime," says Ben Yearsley, director at Shore Financial Planning. "Even if you had invested in the FTSE 100 the week before the 2008 financial crisis hit you would still have made money over 10 years."

Other market crashes have been harder to recover from. For example, an investor who put money into the average Investment Association (IA) Technology and Telecomms fund in March 2000, at the height of the dot-com bubble, would only recently have made a positive return, almost 20 years after it burst.

But the opportunity cost of not investing is hefty. If you leave your money sitting in cash, its capital value will be eroded by inflation. And if you wait for a crash, you might wait some time and in the meantime forgo market gains.

Patrick Connolly, certified financial planner at Chase de Vere, says: "The best time to invest is clearly when markets are in the doldrums, when they've already fallen and sentiment is poor - but the challenge is that nobody can time markets. Stocks are riding high now, but it's very possible that markets could go even higher. If you are investing now you have already missed out on a lot of gains, but if you sit on the sidelines you are likely to miss out on even more."

Mr Yearsley adds: "Waiting until the crash comes and then investing sounds like a great idea, but does anyone know when that will be? And even if you do wait, how do you find the bottom, and would you have the nerve to fully invest in one go? I would say that for 99 per cent of people the answer to that question would be no."

The fear of expensive markets should not put you off investing altogether. And you should not steer clear of whole regions just because the major benchmarks in those countries look stretched. All investors should hold a well-diversified portfolio, with a good mix of asset classes and exposure to a wide range of countries. So do not avoid the UK or US.

But do be mindful of the way in which you put money into the market, and the style and type of investment you get exposure to.

 

Invest the smart way

One way to mitigate risk with new investment money is to feed it into the market gradually to spread your risk and make the most of pound-cost averaging. Dividing your potential pot into a set number of payments and deciding a date to pay in the cash each month means that you are not trying to time the market.

With this method there will be periods when you buy stocks and funds when they are expensive. But your set sum will buy fewer units or shares than in periods when the market is down. When the market has fallen, meanwhile, you will buy at cheaper prices, meaning you purchase more units or shares with the same amount of money.

This is a regular investing model, and will probably mean splitting your money evenly between a range of funds.

If you would prefer to invest lump sums you could determine an asset allocation and a range of funds with which to express it, and then put money into the least expensive markets and areas first.

"You need to determine an asset allocation if you are starting out investing, but how you execute it is the important thing," says Jason Hollands, managing director at Tilney Group. "You might want to start by focusing on the areas of the market that are the best value and phasing your investment in tranches.

"The only markets that really do look cheap in the traditional sense today are emerging markets. So if you are setting up a new portfolio you might want to focus on Asia and Emerging markets first, and some of the more reasonably valued developed markets," he says. "Japan is to some degree good value and the European market offers relatively good value compared to the US, which is looking very extended."

If you are already invested, be disciplined about rebalancing your portfolio.Make sure your portfolio's asset allocation is in line with the plan you set at least once a year, by taking profits from the areas that have outperformed.

"Take profits from the areas that have performed the best and reinvest into areas that have performed the worst, and effectively you are managing the level of risk you are taking and selling at the top of the market and buying at the bottom," says Mr Connolly. "You should do it at least annually, but if there are major market movements you may want to do this more frequently. Strong market performance should be seen as a warning sign and not an invitation to start buying. For those already invested or looking to invest, manage risk both by investing regular premiums and by being disciplined with rebalancing."

 

Spread your risk

Diversification is another key way to spread risk in your portfolio. By holding a mixture of assets and geographies you should be able to mitigate losses in one area with good performance in others. It is worth bearing in mind that asset classes are more correlated than in the past, so it is likely that some contagion will occur if one part of your portfolio suffers.

Investing in funds run by good active managers and in less crowded investment styles could offer some protection against downside. In areas that look stretched, there are stocks and sectors you can avoid when you are concerned.

Mr Hollands says that he would avoid broad US index tracker funds just now, as these are exposed to the most expensive stocks. Instead he would seek value managers.

"Traditional, broad trackers are inherently chasing the assets that have grown by the most, meaning you will feel the full brunt of the downside if there is a sell-off," he explains. "In recent years it has been very popular to use an S&P 500 tracker fund to get US exposure, but if you share the view that the market is expensive you might want to choose a fund with a value approach or an exchange traded fund (ETF) with a value tilt."

Examples include PowerShares FTSE Rafi US 1000 UCITS ETF (PRUS), which tracks an index that uses fundamental measures such as company size, sales, cash flow and dividends to determine a stock's weight in it.

Mr Yearsley adds: "I am nervous about valuations in the US market and was considering selling my exposure recently. However, when I looked at the fund I hold - Legg Mason IF Clearbridge US Equity (GB00B8F2KD97) - it was on a price/earnings ratio (PE) of 15, in contrast to the market on a PE ratio of 21, so there is really no need to sell as I am not investing in very expensive stocks via that fund. In any market you can hold a mixture of styles of fund, and should hold different styles to achieve diversification."

Active fund managers can also take defensive measures such as holding a greater proportion of their fund in cash. Mr Hollands says a large number of fund managers in the US and UK are currently running fairly high cash weightings, including John Wood, the experienced manager of JO Hambro UK Opportunities (GB00B95HP811). At the end of May this fund had 27.9 per cent of its assets in cash.

Mr McDermott says: "If you have a low tolerance to risk you might want to invest in a more defensive equity fund or a multi-asset fund, which might fall by less than the market if it does go down. If I had new money to add to markets today I would add it to Europe, Japan, Asia and emerging market equities, rather than the US and the UK. But you need to consider your risk appetite and time horizon. If you are invested for five years and equity values are high, that poses a different set of questions and answers than if you are invested for 20 years or more. Over the long term you are likely to make money in equities."

Mr Hollands thinks you should take aggressive positions in the market when the time is right. "Be sensible, invest regularly or phase in money, and if you are convinced that markets look expensive seek out more defensive or value-style funds or a fund where the manager is holding a chunk of cash," he says.

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By Kate Beioley ,
15 June 2017

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