Financial markets ended 2023 on a positive note albeit being highly volatile and unpredictable. Now, it is the start of a new year, 2024, with fresh hopes and interesting predictions. Hence, it is good time to consider some important tips that may help navigate through another challenging year ahead.
Macro forecasting is important, but forecasting is hard and it rarely proves exactly right
Perhaps one of the top tips is to realise that predicting future is very difficult, specifically when it comes to macro forecasting. Howard Marks, one of the greatest investors of our time, founder and Co-Chairman of Oaktree Capital Management with more than US$170 billion assets under management is a dominant speaker on this topic, through his memos, media appearances, and other platforms. According to him, “Macro forecasts are very important. The only problem is they’re rarely right, and more importantly any one forecaster is rarely right more often than the others. So, we don’t make our decisions on that basis”. One of his famous examples is the 2016 US elections. There was a wide consensus that Hillary Clinton will win the election against Donald Trump. But, if somehow, Donald Trump wins, the markets will crash. Ultimately, completely opposite happened against those both forecasts. Here are couple of other examples of recent past:
- Based on consensus, the year 2022 was strongly believed to be the year of good returns after a spectacular 2021 performance following Covid-19 vaccine roll-out. However, 2022 proved to be a nightmare for investors for both equity and bond investors.
- Then comes year 2023, the consensus forecast was for another bad year for financial markets because of very high inflation figures, ultra-high-speed increase in interest rates, wars, banking turmoil, and expectations for a deep recession. But 2023 was recorded as one of the best years for markets.
Now we are at the start of 2024. What is the consensus? everybody is a bit confused (based on what the above three macro predictions did to them). Consensus is still shaping based on the expectation that central banks will pivot and will cut interest rates.
At Simply Ethical, we value the importance of understanding the macro-economic environment, which certainly helps in investment decision making, however, forecasting macro and getting it right all the time with precision is not always possible. Our investment process combines both top-down and bottom-up approach to formulate our investment strategies and construct portfolios based on investor objectives and risk profile. Top-down investing means making investment decisions based on the outlook for the economy and what that is likely to mean for individual assets. We look at various macroeconomic indicators including economic growth, inflation, interest rates, currency movements, political developments and global trends to help us identify key investment themes and opportunities in various sectors or industries. This helps determine our asset allocation parameters for various investment strategies.
Getting asset allocation right is key
If anything, we have learned from the history of financial markets is to get asset allocation right given very uncertain and unpredictable nature of the markets. Asset allocation is key to avoiding significant drawdown in your investment portfolio value if things go wrong. By picking the right collection of assets, you may be able to limit your losses and decrease the volatilities of investment returns without forfeiting too much potential profits.
Diversification can help reduce investment specific risks
Do not confuse diversification with asset allocation. While asset allocation refers to the percentage of stocks, bonds/sukuks and cash in your portfolio, diversification involves spreading your assets across asset classes within those three buckets. Both are closely associated but are bit different. Diversification is beneficial for your investment journey. Remember the famous phrase we all are aware of, “do not put all eggs in one basket”. This is perfectly right in investing as well. You never know which asset is going to be the winner, and which will be the loser. Diversification helps you to limit the downside risk that comes with portfolio concentration while helping to achieve good returns over time.
Fixed income asset class looks attractive
Fixed income asset class (Sukuks) is an interesting investment which provides decent regular income along with potential returns from capital appreciation. However, it is highly sensitive to interest rate movements (values drop when rates rise and vice versa). It had a tough time in last couple of years when rates were rising. Now, the expectation is the rates have peaked and they will start falling 2024 onwards. Assuming it does happen, fixed income offers attractive entry point as higher yields can be locked-in for some years to come. In addition to that, there is a potential for capital gains when rates start falling (as bond prices rise when rates fall). Adding both returns together will add decent total return to your investment portfolio in short to medium term future.
Commodities can be a good diversifier asset class
Commodities can be a good addition to your investment portfolios due to number of reasons. For example, commodities (i.e., gold, silver, platinum, copper) generally do well during economic expansions because of their use in the industry. Assuming the coming years would see easy monetary policies from the central banks that will support economic growth, commodities will become attractive. Additionally, commodities like gold also provide a natural hedge in a diversified portfolio against fluctuations in the US dollar. For example, if dollar depreciates against major currencies, returns from sukuks could be impacted as they are mostly dollar denominated. However, dollar depreciation is good news for commodities as they become more attractive for international importers. Moreover, many commodities are expected to experience a deficit in coming years, but demand is expected to rise at the backdrop of economic expansion. This supply-demand imbalance can push commodity prices higher in coming years.
Take a long-term view on investments
You need to realise that investing is for the long term. Nature of the financial markets is very uncertain and unpredictable. Asset prices can be influenced by a number of factors other than their fundamentals. However, in the long term, their values tend to move along with their fundamentals. Knowing that economies work in cycles, and different stages of economic cycles take years to shape. Therefore, to successfully navigate through those economic cycles, a long-term perspective in investing is the right thing to do.
Respect the ‘Mr Market’
Market volatility is part of the game, no one can avoid it. Rather, you should consider it the opportunity to get better deals. I would say volatility is a friend of long-term investors. Every day, it offers you something valuable. It’s up to you if you take it or ignore it, the market does not mind it, and it will return the very next day with more opportunities. Therefore, if the market annoys you in 2024, try to find value from it. Remember, you are in this game for the long-term, and markets generally go up over time amid growth in economies and corporate profits, innovations, and many other factors.
Know your risk appetite before investing in stocks
Investing in stocks is not for everyone. It is known as the riskiest investment of all (crypto has taken the lead since at least last decade). However, sometimes risk is worth to take on. It all depends on your risk appetite. If you cannot sustain the level of volatility stocks can have, you should mix this asset class with other less risky investments to diversify the investment risks. It is always better to consult a financial adviser before making any investment decisions.
Stay invested
This is really important as high inflation erodes the value of uninvested money. One of the important goals of investing is to beat inflation over time so that you protect the real value of your money and to further grow your wealth. No doubt, investing comes with risks and your investment values can fall as well as rise, however, not investing is not a solution. Keeping your money under your mattress means a guaranteed loss, however, you can compensate that loss through investment income and capital gains.
Patience is a virtue
Keeping calm and controlling your emotions during increased market volatility is difficult but it is the right thing to do. The most prudent approach to adopt while making investing decisions is to pick high quality investments and diversify your portfolios across and within different asset classes. Quality and diversification would protect the investment portfolio from drawdowns under heightened market volatility. If you are a true believer that economies will grow over time, which they tend to do as populations nurture and productivity improves, then you will expect corporate profits to increase and with that the investment values too.
Build an emergency fund for difficult times
Having an emergency fund is vital to avoid any unforeseen financial difficulties e.g. loss of job or bad health etc. It is prudent to hold an equivalent of 6 months expenditure in a readable accessible bank account. There is a famed quote accredited to Great Depression-era economist John Maynard Keynes – “Markets can remain irrational longer than you can remain solvent”. It is important that investors consider this idea with greater care. This is the nature of the markets; therefore, it is best advised to adapt with the markets.
Utilise your ISA allowance to the maximum
Do not forget to utilise your ISA allowance to grow your capital tax free. The ISA allowance for 2023/24 is set at £20,000 and for Junior ISAs it is £9,000. One can utilise this allowance before 5th April 2024 and the same amount after 5th April 2024, assuming government does not change the limit for 2024/25.
If you need further tips, book a free consultation with our Financial Advisers
To learn more about how we can help you and about our investment approach, book a free initial consultation with one of our Financial Advisers.
Disclaimer
This article is for information only. Please do not act based on anything you might read in this article. Past performance is not a reliable indicator of current or future returns. This article contains general information only and does not consider individual objectives, taxation position or financial needs. Nor does this constitute a recommendation of the suitability of any investment strategy for a particular investor. It is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any trading strategy to any person in any jurisdiction in which such an offer or solicitation is not authorised or to any person to whom it would be unlawful to market such an offer or solicitation.
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