Some savers may currently be deterred from investing their longer term savings in stocks and shares, mindful that shares have already experienced a long period of growth since the financial crash of 2008. Share prices in the FTSE 100 are now more than double on average than at the bottom of the market in March 2009*. So is the market due for a fall in value?
It is certainly true that the ratio of share prices to the earnings made by companies, known as the price earnings ratio, is historically high. This does not necessarily mean that prices will fall immediately, nor that all shares are overvalued, but it can be an indicator that growth in share prices may be about to slow down.
The problem with trying to time investment to buy after, rather than before, a market fall is that no one knows when this will happen until it has. It is extraordinarily difficult to get the timing absolutely right. Waiting for a fall in values can mean missing out on dividends and growth in the meantime. For those who have not yet used their allowance for tax free savings in an Individual Savings Account, it can also mean choosing between investing a larger lump sum in one go or missing out on building up tax free savings on the other.
So what is the answer to this dilemma?
One strategy which tends to work well over the medium to long term, is to buy shares on a little and often basis. This can be achieved by subscribing to an investment fund on a monthly basis with payments funded via a direct debit.
While it is possible that share prices could go up or down in future, by investing little and often and only the amount you can afford to tie up for 5 plus years, your investment need not be wholly exposed to the market in one go, nor be withdrawn after a fall in value.
If share prices fall, savers benefit by being able to buy more shares each subsequent month and so are in a position to make gains from any future upturn in prices. Over the long term this can help to even out any losses made on earlier month’s purchases.
In the event of a significant fall in share prices, investment of the balance of the money available for long term saving could be made as a lump sum to take advantage of lower prices.
Equally the investor can cancel the direct debit at any time and choose to place the balance of their savings in cash. Cash can later be transferred to riskier investments when you feel able to take risk once more. Should you wish to take less risk, the transfer from shares to cash can also be made.
Those savers who have not yet made their annual Individual Savings Account (ISA) investment need not miss out on the current year’s allowance (up to £20,000) just because they are nervous of short term market momentum. The whole of the ISA allowance can be placed in the stocks and shares ISA wrapper but held either wholly or partly in the cash fund of the ISA and then switched at regular intervals into the investment funds. The cash funds offered do not pay very much interest and are not intended for longer term investment. They may not even cover the charges for the ISA or inflation. However, they allow the nervous investor the benefit of taking up their annual ISA allowance before the 5 April deadline but still having the option of timing the investment into stocks and shares over a longer period.
An alternative strategy is to invest the available allowance in a cash ISA. The ability to move between the two types of ISA (cash and stocks & shares), adjusting the risk taken, can enable ISA savings to be used for both short term and longer term needs, balancing risk and accessibility to match changing personal circumstances. Most ISA managers make no charge for transferring to an alternative ISA provider. To preserve the tax free status, the transfer must be from ISA manager to ISA manager and not via the individual’s bank account.
By starting your ISA savings near the beginning of the tax year, a little and often drip feed of funds into the market can be achieved and over the medium to long term helps to smooth out the ups and downs of stock market returns. A regular direct debit payment also means that you do not risk missing out on the full potential of tax free savings by forgetting to add to the ISA each tax year.
Director of Public Policy, LEBC
Please remember, no news or research item is a recommendation or advice to buy. LEBC Group Ltd is not responsible for accuracy and may not share the author’s views. The value of investments can fall as well as rise and you could get back less than you invest. If you are unsure of the suitability of any investment or product for your circumstances please contact an Adviser. The Financial Conduct Authority does not regulate tax planning. Tax rates and allowances may change in future.
*FTSE 100 closed at 3530 on 6 March 2009 and at 7327 on 5 December 2017, source Yahoo FinanceBack to News & Views