For UK investors, the FTSE 100 is often the first port of call when considering their investment options. However, the combination of continued spikes in volatility and the number of different ways one can invest means that the method used to gain exposure to the stockmarket is an important one.
A volatile year
This year has already seen some significant highs and lows. For example, the highest closing value to date was 6087.4 back in early February, whilst the lowest value was earlier this month when the FTSE closed at 4944.4. This is a drop of nearly 19% in less than an eight month period – a warning indeed of just how quickly things can change.
We have also seen the worst quarterly drop since 2002, with falls bigger than those seen during the banking crisis in the third quarter of 2008. All of this should act as a constant reminder of what you can experience when investing as well as a warning to consider carefully how you gain exposure to stocks and shares.
The rollercoaster continues
And the month of October was no different. The FTSE opened at the start of the month at 5128.5. The next day it closed below 5000 (at 4944.4) for the first time since early July 2010 – a loss of 3.6%. It then steadily increased to a peak of 5713.8 towards the end of the month, an increase of just over 15.5% only to taper off at the end to finish yesterday at 5544.2, a loss of 3% in the last two trading days.
In summary, if you had invested at the start of the month and taken out your investment at the end of the month, you would have lost just over 8%. Over half of the month’s trading days resulted in daily falls or rises in excess of 1% with an almost frenzied reaction to every economic story, be it related to the twists and turns of the European debt crisis or further afield. At the time of writing, the FTSE 100 is down 3.4% on its opening value...
What should we learn from this?
We should all be familiar with the warning that past performance is not a guide to future performance, and indeed it would be unfair and perhaps unwise to read too much into any snap shot of the FTSE’s recent performance. Putting money into stocks and shares should be considered a medium to long term investment.
However, what this warning does not help us to clearly understand is that when you make an investment and decide to have exposure to the daily highs and lows of the stockmarket (an individual share, for example), you need to get two things right – the first is when you buy and the second is when you sell. And if you get either of these wrong, you could be facing serious losses, as some of the FTSE highlights above make painfully clear.
One of the benefits of investing in an investment fund is that you are spreading your investment across a number of shares, rather than just one. This has the effect of diversifying your investment and thereby reducing the risk since if one share should fall in value significantly it will not affect your entire investment, only that amount which the fund holds in that particularly share.
However, it is still important to remember that many funds invest in particular sectors or regions and although there can be a wide range in overall fund performance, many are correlated and often move in a similar direction. This is often seen in the FTSE 100 and the banking sector has been a good example of shares all rising and falling together, albeit by different amounts.
What alternatives are there?
One alternative that is rising in popularity is the structured product which provides you with a defined return for a known level of risk at the outset. Although you do not get direct exposure to shares and the historically valuable dividend yield some shares can provide, you do know exactly what needs to happen to provide the stated level of return.
The costs and charges are all factored into those stated returns so there are no hidden surprises lurking to catch the unwary and there are also a wide range of products to meet the needs of different views on what might happen to the market (whether you think it may go up, stay flat or go down).
One such product that can benefit from the current market conditions is the kick out plan. Many provide the potential for a fixed return each year, provided the FTSE finishes higher than at the start of the plan. This means that even if the FTSE has risen by just 1% you could receive double digit returns – particularly attractive in light of the current market uncertainty.
Diversify your investments
Every teacher of investment theory will tell you that diversifying your investment across a number of shares will help to diversify risk, and that there are further diversification benefits available by spreading across a number of different sectors. But it is also important to understand the implications of the way in which you gain exposure to the actual investment.
By providing a separation of your investment from the day to day highs and lows, structured products remove some of the difficult investor emotions associated with seeing your portfolio fall by significant amounts in short periods, something which this year will have tested even the most hardened and experienced investor.
Compare Investing for Growth »
Compare Investing for Income »
No news, feature article or comment should be seen as a personal recommendation to invest. If you are in any doubt as to the suitability of a particular investment you should seek independent financial advice.
The value of investments and income from them can fall as well as rise and you may not get back the full amount invested. Different types of investment carry different levels of risk and may not be suitable for all investors.
Structured investment plans are not capital protected and are not covered by the Financial Services Compensation Scheme (FSCS) for default alone. There is a risk of losing some or all of your initial investment. There is a risk that the company backing the plan or any company associated with the plan may be unable to repay your initial investment and any returns stated. In addition, you may not get back the full amount of your initial investment if the plan is not held for the full term. The past performance of the FTSE 100 Index is not a guide to its future performance.
© Fair Investment Company Ltd