AS we all know, financial markets remain very volatile and, with so much political and economic upheaval, that’s not going to change any time soon. Should we be worried?
In fact, a certain amount of volatility is a good thing because it creates opportunities for fund managers to exploit. After all, a totally flat market would not create the right environment to make and take profits, which funds need to do if they are going to provide reasonable returns.
The concern is that investment values will fall during negative periods and, of course, this is true. But if you are investing for the longer term, then the timing of the ups and downs of markets is not crucial – except, perhaps, at outset when you make your initial investment. From then onwards, it makes no difference whether you get good performance immediately, or later, and whether you see negative returns before positive returns.
For example, for a £1,000 investment over six years which enjoys three years of positive performance and three years of negative growth, it does not matter what order the ‘good’ and ‘bad’ years fall in, the result will be the same. Try it for yourself and see!
The above example saw growth years of +10%, +17% and +5%, with loss years of -5%, -2% & -8%. The end result is a fund value of £1,157.45.
This is fine if you are simply aiming to accumulate capital. It is a very different story if you are taking income from the fund.
Using the same example but adding an annual income withdrawal of £50, if all of the good years come at the beginning, the value after six years would be £872. If the negative years come first though, the end result would be a fund value of £780. As you can see, timing really does matter!
So how can you use this information to your advantage when planning your finances?
The answer has to be in the overall strategy which you should discuss with your financial adviser.
Your finances should be structured to vary the sources that pay you income, in order to avoid taking funds from market-linked investments when values are down. This is only possible if you have spread your investments and have other money you can draw on which is not market sensitive, such as funds on deposit.
This will only work for you if you understand the level of income you can sensibly achieve from your capital over the longer term, have a strategy in place and the determination to employ it when decisions need to be made.
This should be at the heart of your financial planning if you are relying on your capital to provide income. Timing really can make a very big difference.