Today is not the day to look at your personal pension balance. You probably have less money than you did yesterday, and odds are the market will recover from the shock of the referendum. But the Brexit vote may still have long-term impacts for your wealth. If nothing else it should serve as a reminder that markets are risky.
The surprise vote has left markets reeling. But markets tend to over-react to unanticipated events, and if you leave your investments alone they will usually recover. It could take years, or it could take days; the UK’s blue-chip FTSE-100 index is already expected to end the week higher than it started, after recovering most of today’s staggering 8.7% drop.
The big disadvantage of individual pension accounts, like a 401(k) in America, is that you have to bear this risk yourself. If you want high returns you must stomach the twists and turns of the market. But the worst thing you can do is pull out of the market now and lock in the drop.
It is too soon to say what Brexit means for international trade and regulation. At one extreme the EU will hold together, and the UK will work out trade and other deals that keeps its relationships with the EU and other countries largely unchanged (though it’ll mean a lot of late nights for British bureaucrats). On the other extreme, their relationship will unravel, other countries will leave the EU, the euro will collapse, and there’ll be a deep global recession, with more protectionism and political instability.
The only certain thing is that the world is a riskier place and so is your investment portfolio. Other countries’ EU exits, or merely the threat of them, will provoke volatile market swings. And that has implications for your investments, as outlined below.
It might be tempting to buy stocks or sterling while they are down. The problem is knowing when to sell them again. Brexit is not an isolated event that markets will forget next week. It probably means a prolonged period of volatility; what happened today could repeat itself over the next few months or years. What you bought could fall further in price, or it could rise and then collapse again before you manage to sell it.
If you are near a big financial goal (retirement, sending your child to college), you might have been planning to de-risk your portfolio: to take your money out of stocks and put it into less risky bonds or annuities, so that you can have a steady, reliable stream of income. Financial volatility, however, makes de-risking itself risky, because the day you need to take your money out might be a bad day in the markets. It also makes de-risking more expensive, because other fearful investors will be fleeing into those same safer assets, pushing up their prices.
If you are nearing retirement, this kind of reinvesting may nonetheless be the right choice, rather than running the risk of seeing your investments crash—but you’ll pay a higher price to avoid that risk.
If you are young, selling equity (while it’s down) and buying bonds (while they are expensive) today is not a good idea. But even if you do the right thing—which is to do nothing—you still need to worry.
Many people will tell you that time heals all things: that investing for the longer term means less risk because markets have years to recover from bad days. Economists call that assumption the fallacy of time diversification. Yes, it’s true that you shouldn’t pull out your money right after a bad crash, but overall, more time does not make investing less risky, because 30 years of investing means 30 years of risk. The odds are that good years will average out the bad, but there also exists a chance you’ll have 30 years of terrible returns. And with the Brexit vote, the chance of a rough 30 years, while still unlikely, just got a little more real.
However, most of us can’t afford not to take that risk of investing in the markets, because the alternative is no financial growth at all. The price of safe assets will probably remain high for the foreseeable future and bonds will offer very low, no, or even negative interest rates. Faced with a choice between negative yields and more risk—risk may be worth it. (Though again it depends on where you are in life—see point 4.)
Though you can’t shut yourself away from risk altogether, you can still protect yourself by diversifying your assets. Invest in buying or upgrading a home, pay for education, or hold stock in many different countries. We have no idea what will happen, but the worst of it will probably occur in the UK and Europe. If you are invested in a global index fund, the UK is less than 10% of your portfolio.
The EU marked years of unprecedented peace and prosperity in Europe, which meant a relatively stable market (at least if you lived in northern Europe). But it was not perfect and its flaws may have been its undoing. If so, we may be entering a new period with more uncertainty and risk, both political and economic, that makes investing much harder for everyone.