With the FTSE 100 having experienced one of its worst weeks for a very long time, many investors may now be wondering what to do with spare cash they may have. In such a scenario, it is all too easy to become short-termist and focus on what seems to be the most enticing investment opportunity for the near term. Likewise, it is natural to look at other investments outside of the stock market after such a large fall in the index’s level.
However, both of those options could lead to disappointing outcomes. They could even increase overall risk and reduce potential returns.
Short-termism
Whenever shares fall, the natural reaction of any investor is to sell up and walk away. After all, logic says that there must have been some hugely significant event which means that the company in question is suddenly worth less than it was a matter of days or even hours ago.
However, the stock market is not always logical in the short run. That’s because its price movements in the near term are made up of the emotions of investors at that particular time. These emotions can be exaggerated so as to provide valuations which, in the long run, often bear little resemblance to the intrinsic value of a specific company.
In the case of the FTSE 100’s recent fall, expectations regarding inflation have increased. This could mean a faster pace of rising interest rates over the coming years. However, the reality is that the world economy continues to perform well. Furthermore, it is unlikely that policymakers will suddenly become excessively hawkish and risk choking off the global economic growth outlook. As such, selling shares does not seem to be the right move to make at the present time.
Relative appeal
Similarly, share price falls can lead many investors to believe that it may be the right time to invest in other assets. After all, falling share prices destroy wealth, and other assets may provide more stable returns in the long run.
Right now, the prospect of an interest rate rise may cause some investors to determine that cash is a good investment. While keeping some cash on hand is always a good idea in case of an emergency, the reality is that interest rates in the UK are likely to lag inflation for many years to come. Therefore, on a real-terms basis, cash is likely to continue to provide a negative return in the coming years.
Similarly, rising interest rates could hurt the prices of fixed-income investments. And if the world economy is performing well, it seems more logical to share in that success through being an equity holder rather than a lender. Furthermore, with buy-to-let investing becoming even less tax efficient and it being more difficult to obtain a mortgage for property investing due to new rules, shares continue to offer a better overall risk/reward ratio for the long run.