Since 23 June, the investment world feels as though it’s been turned on its head. What seemed like a fairly predictable future for the UK economy in terms of a gradually rising interest rate and further austerity is now very unclear. Interest rates could be cut, government borrowing could rise, but one thing is for sure: Brexit means Brexit.
Don’t overreact
Of course, in some ways, nothing has changed since the EU referendum. Investors are still more focused on the short term than the long term and that’s one of the key lessons I’ve learned from Brexit. In other words, investors panic due to fear even when the long-term outcome is extremely unclear, with share prices of UK-focused companies falling massively in the days following the EU referendum before rising again in the last couple of weeks.
This overreaction to news that may or may not be positive presents an opportunity for more patient, long-term investors to buy-in at a lower price. Certainly, it can be difficult to stay out of the investment herd, but by doing so there are bargains on offer and their purchase could lead to increased returns in the long run.
A second lesson I’ve learned from Brexit is that there’s a risk in every event and investors must price this in. Although the result of the EU referendum seemed to be close in the run-up to 23 June, many investors had priced in a Remain vote and so they were surprised when Leave won. This led to chaos in the days following the referendum as they quickly priced-in the uncertainty and potential economic slowdown that could be brought about by Brexit.
This shows that even if the outcome of an event seems likely, investors must correctly price-in risk. The easiest way to do this is to demand a wider margin of safety than usual, which means that a bigger discount to a company’s intrinsic value provides a greater safety net in case of negative news flow. While this may lead to us missing golden opportunities to buy great quality companies, it should ensure a more robust risk/reward ratio in the long run.
Diversification
The third lesson I’ve learned from Brexit is that diversification is crucial. As mentioned, in the days following the EU referendum, UK-focused stocks such as housebuilders, banks and retailers have seen their share prices come under severe pressure. Meanwhile, international companies have risen thanks in large part to a weaker sterling causing a positive currency translation.
Therefore, it’s important for all investors to diversify both geographically and also in terms of buying companies operating in different sectors. Brexit could lead to a further weakening in sterling, which may mean an increased number of bids for UK-listed companies, while Brexit could also boost the UK’s economic performance and make banks and housebuilders much more profitable.
At the present time, we simply don’t know how things will turn out and so that’s why diversifying among high quality companies that offer wide margins of safety is a sound long-term move for all investors.