I think that most people understand why investing in the stock market is such an often-employed strategy for growing retirement savings. The power of compound interest can magnify a relatively small amount of initial capital into truly large sums of money over a long enough period of time. For instance, investing £5,000 a year for 50 years at a fairly conservative average rate of 5% will yield a final pot of £1,156,414! In other words, you can become a millionaire by the time you retire by making relatively small adjustments to your lifestyle.
However, there is an important caveat to this attractive arithmetic, and it’s one that isn’t discussed nearly enough, in my opinion. Compound interest can only work its magic if you do not suffer periods of capital loss. To make money, you first need to not lose it. Over the last 12 months, market uncertainty has risen significantly. Here are just some of the things that capital allocators are currently fretting about: the Iranian crisis, the US-China trade war, Brexit and the upcoming US election. My colleague Alan Oscroft recently wrote about these issues and more. Here’s what I think investors should do to solidify their portfolios.
Diversify, always diversify
One way to protect yourself against losses is through diversification. Nothing in the stock market is certain, so successful investors like to spread their money around in order to protect themselves against potential downturns. At the most basic level this means not putting all of your money into one stock. Oftentimes, it also means buying shares of companies in different industries, or different countries — this is to ensure that your portfolio is not adversely affected by a single event that affects a specific sector or market.
For instance, you may consider investing in the property sector. For investors looking to gain exposure to this market, buying shares in a REIT is one of the best choices available. A REIT (real estate investment trust) is a company that owns a portfolio of properties that it manages, and that pays out 90% of its income as dividends to its shareholders. Landsec is an example of a REIT with some premium properties in Central London.
Another option that you might consider is to buy gold. The precious metal has been performing well lately, going from $1,300 per ounce in January 2019 to around $1,550 per ounce today. That’s a 16% increase — not bad for an asset that typically does not move that much. The conventional wisdom is that gold is a hedge against inflation, but I think its real value comes from it being a hedge against uncertainty. The value of gold tends to rise during uncertain times when investor money pours into the metal. Another great advantage is that it is a real asset, which will always have a value (unlike Bitcoin, for instance).
And if you don’t want to buy real gold, you could opt for shares in gold miners instead, so there’s more than one way to profit from the precious metal.
Whatever diversification route you choose to go down, remember Warren Buffett’s two rules for investing: “Rule number one is don’t lose money. Rule number two is don’t forget rule number one”.