Your essential guide to investing through a no deal Brexit
What effects might a no deal Brexit have on your investments? With the new prime minister committed to Britain leaving the EU on 31 October, this is a question with big implications.
If you’re just getting started, then here’s a guide to navigating the journey into investing during this political uncertainty.
- Setting your investment stall
- How to invest – DIY, with a professional (active) or with an index (passive) fund?
- Geographic allocation
- What impact will Brexit have?
- Helpful links
1. Setting your investment stall
a) What’s your outcome?
You should always start investing by thinking about why you’re doing it. A holiday, retirement, to pay off your mortgage, tuition fees… you could have any number of reasons, but it’s important you know what they are.
b) What’s your timeframe?
You should also only be investing in the markets if you have at least five years, and preferably seven or more, before you need your money. That gives you enough time to ride out the inevitable peaks and troughs in the market.
If you’re looking to use the money from your investment within the next five years, you should stay out of the markets and stick to deposits.
Historically, over more than 30 years, the stock markets have averaged 9% return per year. In the future, as there has been over that time, there are going to be some really good years and some really lean periods, so you can only get that average if you’re thinking long-term and ride out the flat or negative years.
Time in the market is what rewards an investor, not timing the market (trying to predict the ups and downs).
c) What’s your asset allocation?
Your asset allocation is the composition of your investment portfolio, which is likely to be a combination of equity (stock market investments) and bonds (low-risk or fixed income investments such as government loans). You may also have some property in your asset allocation.
Your personal risk profile – how much risk you’re comfortable taking with your money – determines the ratio of equity to bonds you should use in your portfolio. If you’re prepared to accept more risk in anticipation of higher returns, you’re likely to have a higher allocation of equity in your investment portfolio.
A greater share of equity means you’ll experience more volatility: retracements or pullbacks in the market will affect you more, but you’ll also see greater acceleration during the good times for the markets.
A greater share of fixed income elements to your investing means you’ll see less extremes and a more consistent return – and on average, a lower return.
If you allocate 100% of your investment to the stock market, you would expect greater returns over time than someone with 100% fixed interest investments; but you should also expect greater retracement when the markets dip. And those retracements historically can go as high as 50%, meaning your portfolio value at that time could halve.
Our emotions drive our decision-making. So you’ve got to think carefully about how you’d feel if your portfolio retraced 10%, 25% or 50%. If you’re very uncomfortable with that prospect, then you need to dilute your risk by balancing your portfolio with a greater share of fixed income investments.
You’re never going to like your portfolio falling in value, but you need to dilute the risk until it’s at a level you’re comfortable with – where you can say when the market falls, ‘I expected this, I knew it would happen at some point, and I’m going to weather this storm and ride it out’.
Take as much risk as you’re comfortable with, but not so much that you’ll want to come out of the market early when it falls.
And remember, you don’t have to invest your money all at once, you can do something called pound cost averaging: every month, on the same day, add a fixed sum into your investments. This helps smooth out the market rises and falls if you don’t want to go all-in from day one.
2. How to invest – DIY, with a professional (active) or with an index (passive) fund?
Do it yourself
Setting up your investments yourself can be fun – but with the best will in the world, a professional who does this for a living will always know more.
With that said, if you enjoy the process, then you could consider setting up a smaller ‘satellite’ portfolio using a small amount of capital away from your main investments.
This involves entrusting your investment to an individual or company who is actively buying and selling shares on behalf of their investors to try and come out ahead of the wider market trends.
As with any field, there are so-called ‘star fund managers’ out there who have been doing this for a long time. But many years of academic research has shown that even the best professional portfolio managers struggle to outperform the market and give you a better return than a passive fund after their fees have been taken into account.
Index or tracker fund
An index or passive fund is where you buy the whole market. It’s also managed by a person, but they’re not buying and selling all the time so the fees are considerably lower than with an active fund.
I recommend index funds based on the research mentioned above. Keeping your fees down is essential to providing the best returns on your investments.
3. Geographic allocation
We live in a global world, and that’s also true for your investing. Your portfolio should be globally weighted, not just focused on your home market. An international index fund will do this for you automatically.
Global diversification is particularly important given Brexit implications. One of the effects we’re seeing right now is the weakness of sterling against the dollar and euro.
If you’re investing globally, you can benefit from this: suppose part of your investment is in the US, and the exchange rate was $2 to every £1 at the time you invested. If the exchange rate were to fall to $1 to £1, you’d effectively have twice as much capital when you converted your investment back into pounds.
That’s obviously an extreme using fictional numbers, but it illustrates the point well that investing globally and not just in the UK is important.
4. What impact will Brexit have?
After the referendum result in 2016, the UK markets plummeted rapidly for a few hours. But when the US markets opened later that day, they started rebounding quickly. Since the referendum the markets are up considerably both in the UK and around the world.
Everybody said in the run-up and immediate aftermath of the referendum that a Leave outcome was going to be terrible news for the markets… and everybody is saying in the run-up to a potential no deal Brexit in a few months, that it’s going to be terrible news.
The truth is, I don’t know what will happen after 31 October – and neither do other commentators. When people are talking about the future, they’re giving you their opinion. Nobody can predict the market future with certainty.
We don’t know if the markets will go into retracement, or if they’ll continue to grow. Which is why the approach above regarding your risk tolerance and long-term thinking and global asset allocation is so important to weather whatever happens next.
The markets will fall at some point, whether because of Brexit, corporate collapse, terrorism or something else. But I don’t know when, neither do you, and neither do the commentators in the media. You’ve got to filter out that noise, and stick to your investment strategy.
Think, ‘I’m going to’:
- Allocate £x to the markets
- Invest globally
- Use an index fund to keep my fees to a minimum
- Think long-term and not pull out if the markets fall
And then follow through on that path. We can only focus on what we can control, and Brexit isn’t something we can control!
Over time, the original mix of equity:bond that you set up your portfolio with will naturally change. Suppose you had a 50:50 ratio at the start – after a couple of good years in the markets, the equity half of your portfolio will have delivered higher returns than the bonds, so your balance may now sit at 60:40, or higher.
That’s where rebalancing comes in – altering your portfolio to keep it close to your original ratio. Typically, you’ll be buying more equity when the markets are falling, so that when they recover you’ll be in position to take advantage.
You only really need to check on your balance once a year, but if there’s a big drop in the markets, that’s an opportunity to look carefully at your ratios.
- You can complete a risk questionnaire here for just £10, and you will be able to assess how much of your portfolio you should consider allocating to equities
- lexo.co.uk is an online platform to allow you to invest simply and conveniently in index funds. There are 10 portfolios to choose from based on your risk tolerance, with a minimum investment of £10,000