Many people put off investing into an ISA for fear of loss. Instead, they wait until the markets are sounding buzzy, everyone feels great, and the TV is telling us all about how much the markets are rising.
Like every party, that’s normally the end of the evening, before you are dumped out in the rain with no taxi.
With a lump sum like the maximum that can go into an ISA of £20,000, it’s not a nice feeling when you see your next valuation starting with a one. That’s natural.
Understanding how markets fluctuate is important to taking away that stress, and reframing the volatility as a friend.
Now, before I explain that, never accept poor performing funds (that represents the majority of funds available). Don’t mix up volatility with poor performance. A fund manager who is clueless and provides greater risk for less return, rather than the obvious opposite, isn’t a good thing.
A fund invests into a range of shares and spreads it across them to minimise risk. The manager has a team of analysts and researchers who choose where to spread that capital. If they are skilled and make good decisions, you are quids in. If not, it’s boring and you are paying for it.
Assuming you have an Independent Financial Adviser (IFA) who is skilled at fund choice, they may guide you to the better funds available. In a unitised fund (I’ll explain), you buy a share in a spread across these stocks/shares. As those shares move around in value, your share across them moves in value, both up and down.
Assuming it’s a good fund, (see above re IFA) if the price falls, it means the spread across those shares and stocks has fallen, which may well represent a buying opportunity. If they rise, that may well represent a selling opportunity.
Naturally most people don’t like to buy when things are down as they translate that as gloom and risk, but the correct answer is counterintuitive. Buying ‘when things are up’ is buying when things are ‘happy’, but potentially expensive.
And so, to take the emotion out of it, it’s potentially an easier task to simply set up a direct debit for your annual ISA allowance. Each month as the market moves around you are buying on each of the dips, taking advantage of their discounted price.
This is called pound cost averaging and is easy to reframe as the year goes by. If the market is being battered, you will know you are buying your spread in the stocks in the fund at a cheaper price. So, it’s worth considering moving to that regular investment rather than the lump sum.
Of course, you could then be bold and take advantage of any sharp downturns that occur if you had any capital aside.
On that note, try to avoid buying ‘this year’s winners’. It will hurt at some point. For example, a fund that was exposed to oil over the last two years probably did so by mistake (or inside knowledge!).
Right now, they would be looking good on the performance tables. Over one year, they look great. Over two, same applies. Over three and five years they also look good but that’s only because the last two year’s performance skews the three and five years as it’s in that data. You will be counting the performance twice. Take those third, fourth and fifth years in isolation, and they will be brutal.
And so, the ‘winner buyer’ buys today’s momentum at its most expensive price and receives a broken nose. It’s a common mistake.
Even assessing a fund on individual years doesn’t work. You need to go much tighter than that. We look for the best funds by assessing on discreet months to try and take any spikes out of the information avoiding today’s over exuberance and tomorrow’s hangover.
The key is also to use five years of information as these straddle different market conditions showing clearly any shocks and allows your analyst in the IFA to stress test. You don’t want a surprise on the downside. Safety first.
If you have a question on ISAs or Investments and would like a complimentary conversation, please ring 01872 222422 or email [email protected].
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