Telling the difference between the weather and the climate.
When thinking how to invest your pension or ISA, we often focus too much on what is going on in the present. And right now global markets are giving investors a rough ride as they adjust to a slowing Chinese economy. But while falling markets can be worrisome, maintaining a longer-term perspective makes the volatility easier to handle and can increase the chances of achieving your long term objectives.
A typical response to unsettling markets is feeling the need to check the business news regularly, perhaps daily or even hourly, to see how the FTSE or Dow has moved in the intervening period.
In most cases, it’s a pretty harmless activity. It at least provides a bland conversation starter in fleeting social encounters, just as keeping up to date with tomorrow’s weather forecasts can fill an awkward silence.
But our very human focus on the day-to-day can often encourage us to make bad decisions that affect our long-term interests. That’s because while we live moment-to-moment, what often affects us most are imperceptible, gradual changes that occur over many years. Trying to keep up with market sentiment based on news headlines is akin to watching Murray versus Djokovic at Wimbledon. You’re liable to get a crick in your neck keeping pace with the volleys.
From minute to minute, market sentiment shifts in reaction to news—news about the economy, companies, governments and politics, and the wider world. Prices rise and fall in response to this news, which by definition is unpredictable.
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Graph 1 – The Weather (Monthly % change in FTSE All Share index to August 2015)
If you look at graph 1, you’ll see the monthly moves in a common barometer of the UK share market. All you see are the monthly ups and downs – the regular changes in the “weather”.
Another way to look at this movement is to measure the growth of wealth – this is shown as graph 2. Using the same monthly returns we can see how an investment made in September 2005 may have grown over the past 10 years.
Graph 2 – The Climate (Growth of wealth of FTSE All Share Index for the 10 year period from September 2004 to August 2015)
Looking at the stock market movements this way, we are less focused on the day-to-day or month-to-month movements, but more on how wealth accumulates through time. Using this example, £1 invested in the FTSE All Share index on 1 September 2005, would have grown to £1.83 over the 10 year period to 30 August 2015 (ignoring any taxes and fees).
When deciding how to invest your pension or ISA savings, this longer term perspective is a more important measure because it takes into account cumulative gains (and losses) over time. Whereas, the media, by virtue of its regular news schedule, must focus on the short-term.
These two ways of looking at the market are like the difference between the weather and the climate. The former changes constantly, the latter more gradually. With long-term investment, such as your pension or ISA, it’s the climate you need to think about.
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