Stop worrying about market timing

"My main goal is growth with capital preservation," says Mark. "Most of my wealth - £20,000 - has come from inheritance, which I invested in the stock market – I have been investing since I was about 18. And my university fees were paid on my behalf.

"I am fully aware that with my income and assets I could put down a deposit to buy a home, but because of the income to price ratios in London I would prefer to invest in assets other than London residential property at present.

"I have done very nicely from the stock market and used to have a good global spread of investment trusts with some defensive shares. However, over the past year I sold these and rotated towards more defensive assets given equity market valuations. However, I am now wondering if I made the correct move as I have no immediate requirement for this money.

"I am not necessarily concerned about my investments going down in value so long as the reason for buying originally hasn't changed. What I am worried about is buying back into equities at their current valuations, and then watching them readjust down to more sensible levels knowing that I shouldn't have bought in at such expensive prices.

"I am comfortable having around 10 per cent of my portfolio in peer-to-peer loans via LendInvest, because they are secured against commercial property, which means there is the potential to recover their value if they default.

>The most reliable lead indicators we have, such as foreign buying of US equities and global price-money ratios point to only mediocre returns, which implies significant downside risk

"I enjoy undertaking research on the Alternative Investment Market (Aim) companies recommended by Investors Chronicle columnist Simon Thompson and, if I agree with his view, investing in them.

"I lost around £5,000 when I was at university by investing in Rolls-Royce (RR.). But in hindsight, that was a good move as it taught me a lesson, and the money I recouped from that investment was reinvested in Burford Capital (BUR). I think I am overexposed to this fund but my average buy-in price was 235p, and I believe in running your winners and cutting your losers.

"I have recently invested in Primary Health Properties (PHP) and Forterra (FORT), and trimmed my holding in Telford Homes (TEF) by £1,000.

"I am thinking of investing in defensive shares such as Unilever (ULVR), National Grid (NG.) and BAE Systems (BA.). I would also consider investing in anything Simon Thompson recommends as he pointed me towards Burford Capital – I wouldn't mind investing in another company of that type."

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THIS READER'S CIRCUMSTANCES.

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

You ask whether you’ve made the correct decision to shift into safer assets in light of high equity valuations. I can't say whether it's the correct decision, because nobody knows the future. But I can say it's a reasonable one. We're at that time of year when there's unusual downside risk to equities. And the most reliable lead indicators we have, such as foreign buying of US equities and global price-money ratios, point to only mediocre returns which implies significant downside risk.

However, you should not be thinking in binary terms such as correct or incorrect, or in or out of equities. The best thing someone of your age can do is invest regularly, for example via a direct debit into a pension or individual savings account (Isa). Such a process means you'll buy fewer shares or units when their prices are high, and more when they are low.

You should not worry about being right or wrong - everybody is wrong occasionally. Instead, you should have good sustainable habits such as saving regularly, and an asset allocation you are comfortable with.

Laith Khalaf, senior analyst at Hargreaves Lansdown, says:

There’s a lot to like about how you go about investing: you've started young and invested an inheritance when it would have been easy to spend it. But I think you seem to be worrying too much about market timing: no one knows when it's a good or bad time to enter the market.

Regarding all the money you're going to invest in the stock market over the next 40 years, sometimes you'll be lucky and sometimes you won't. It's not under your control, but it will even out in the long run – so a better use of your time would be to concentrate on picking good companies and funds, and making sure they are held tax-efficiently. So if you don't hold these investments in a tax shelter, consider putting them into an Isa or Lifetime Isa.

It's good that you’ve taken a bad investment experience and learnt from it. Even the most seasoned fund managers make bad decisions, so it's important to understand that this is part and parcel of investing, and when it happens you need to dust yourself off, learn your lesson and move on.

James Norrington, specialist writer at Investors Chronicle, says:

Firstly, you are to be applauded for starting investing so young. Thanks to the magic of compound returns, you are giving yourself a better chance of having enough money in around 40 years when you are approaching retirement age. You also have a good income at a young age, so have the security of not having to live off your investments. Coupled with the time you have to recover from losses, this means you have capacity to invest in riskier assets such as equities which, despite high valuations in some regions, look like the best bet for generating above-inflation returns.

You seem to be slightly obsessed with market timing but at this stage in life, and in your circumstances, time is your friend. There are stock markets that are not so expensive, for example the reflation trade in the eurozone has further to run and there is still value in Japan. If you are worried about expensive markets like the US S&P 500 and some FTSE 100 sectors, then just have an underweight holding in these regions. You won't lose as much in a correction and until this comes you won't be missing out on further upside. 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

Your portfolio is curious. It looks like a 'risk barbell' construction – high-risk speculative assets alongside lots of index-linked gilts via your holdings in Capital Gearing Trust (CGT) and Personal Assets Trust (PNL).

And other than Primary Health Properties and the defensive stocks in Personal Assets you've few ordinary low-risk equities.

For me, this is a problem. You are to a large extent depriving yourself of two traditionally good sources of return. One is the tendency for the general market to rise over time. The other is the tendency for defensive stocks to do better than they should. The virtue of defensives is not so much that they protect you from market falls – if the market drops they'll fall too, although probably by less – rather it is that they beat the market on average.

But by focusing on Aim you are exposing yourself to an asset class that traditionally underperforms. Aim stocks have fallen on average over the past 20 years, not least because investors pay too much for the small chance of huge outperformance. Burford Capital is very much an exception.

One common mistake people make is what psychologists call base rate neglect - in looking at individual cases they neglect general probabilities. And Aim investors often do this: they see what looks like an attractive stock and neglect the fact that the chances of small speculative stocks doing well are not great.

I also fear that, insofar as you are taking on systematic risk, you're exposed to cyclical risk. In the event of an economic downturn, you'd suffer losses on your housebuilders and probably on your other Aim holdings as sentiment to the market tends to be cyclical. You might also see losses on your peer-to-peer loans as defaults rise: don't be wholly confident that the lending is secured, as a downturn would see the collateral devalued.

My general advice would be to diversify away from Aim. Someone of your age should be investing regularly into a tracker fund. Aim is like a racecourse - it might be a place for an enjoyable flutter, but it shouldn't be the centrepiece of a financial strategy.

Laith Khalaf says:

I don't think there's anything wrong with keeping some defensive assets in your portfolio, but given the long time frame you potentially have before you call on the money, I'm not sure such a big exposure to fixed interest is warranted unless you have very high conviction. Besides, if you think equity markets are overvalued, you could make similar comments about bonds. So rather than trying to second guess the direction of markets I would suggest thinking about how much of your portfolio you are happy to have in bonds for the long term, and use that as your guide to positioning the asset allocation.

You also have quite a lot of stock-specific risk - particularly as  you are investing in small companies. While there's nothing wrong with that, and I am loth to discourage you from unearthing hidden gems, consider adding a couple more funds to create a diversified core around which you can add stocks that catch your attention. At the moment it would only take a couple of wrong turns by the companies you are invested in to see a big chunk of your portfolio lost.

James Norrington says:

I like the sound of your original portfolio – internationally diversified collective funds plus some defensive shares is a sensible approach, along with the strategic bond funds you still hold. The concern I have with your current portfolio is the that investments are all very dependent on the UK economy. With Brexit negotiations casting a shadow over the prospects for the country, you are very exposed. The peer-to-peer investments are often loans to small UK companies and you also have several property-linked holdings, which is another area that will suffer if the UK goes into recession. Commercial property would certainly take a significant hit, which has ramifications in terms of the security of your peer-to-peer loans. 

Like some equity markets, UK property is expensive, so your reluctance to take on a large mortgage and risk negative equity in a crash is understandable. This does need to be set against the cost of renting – money you'll never see again – and the opportunity at the moment to borrow at ultra-low rates. But this is a big decision you need to be comfortable with and, in a way, your UK property shares are a hedge if the housing market doesn't crash.

You enjoy investing in some of the smaller companies that Simon Thompson recommends. Many of Simon's picks have done fantastically well, but you need to remember that these are risky investments, so make sure they don't account for too much of your total portfolio. Set a budget for small-caps, say 10 to 20 per cent of your portfolio, depending on what you'd be able to stomach losing in the worst-case scenario, and be prepared for an investment to occasionally go wrong. Of course, uncovering hidden gems that make double- and triple-digit returns can also make a very positive difference to your portfolio.