4 principles of prudent investing

It’s often said stock markets are driven by two emotions: fear and greed. While this may be an oversimplification, we can feel downcast if our investments fall in value and a thrill if they go up.

These emotional responses may be normal and harmless, but a problem can arise if they affect our behaviour. Letting emotions govern investment behaviour can lead to irrational decision-making that could cost us dearly.

We believe four principles underpin a solid approach to managing your personal finances and can help avoid irrational decision-making. As with any approach to investment, there is no guarantee of performance success, but these principles can form the backbone of a sound overall financial strategy.

1. Take a long-term approach

At Schroders Personal Wealth (SPW), one of our key principles is to invest for the long term, which may help you ride out periods of market turbulence.

You may feel nervous when stock markets fall, but a long-term investment mindset can help avoid a knee-jerk sell-off. Once you’ve taken the plunge to invest, it helps to leave your investments to grow and avoid the temptation to test the waters by buying and selling up frequently. Patience is a virtue here.

Adopting an investment horizon of five years or more will hopefully give you sufficient time to reduce the impact of market ups and downs and enjoy the potential benefits of a long-term investment approach. In our view, investment is about spending time in the market rather than trying to time the market.

Even so, investments can fall as well as rise and investment growth is not guaranteed. You could even face the prospect of getting back less than you initially invested.

2. Invest little and regularly

To manage your investments in a prudent way, it can be sensible to invest small sums regularly over time.

This is known as ‘pound cost averaging’, referring to the fact that you are averaging out the cost of investing. This reduces the risk of making a large investment when a market is at a peak, only for you to then lose out when it falls. Smaller, regular contributions could help smooth out the market’s ups and downs in the long term.

Even so, pound cost averaging doesn’t suit everyone. For example, someone who inherits a large lump sum may be better off investing it in one go, or perhaps in several tranches in a relatively short time period. But you may want to speak with a financial adviser before adopting this kind of approach.

3. Diversify your investments

Another key SPW principle is to diversify. This involves spreading your risk by investing in a range of assets such as equities (shares), property, commodities and fixed income investments. Investments that could provide a regular fixed income include government bonds or corporate bonds.

Different investments are affected by different economic and market factors. Holding a diverse range of investments means you hopefully won’t be too exposed to any one of these factors.

A financial adviser can help you set up or maintain a well-diversified portfolio. They can also help ensure you hold a portfolio with a level of investment risk appropriate for your circumstances and in line with your attitude to risk.

4. Have frequent reviews

We believe in the benefits of regularly reviewing your overall financial planning arrangements and the performance of your investments. Even so, you may want to limit how often you check your investments if market fluctuations could lead you to take a snap decision, rather than a reasoned one.

A financial adviser can help establish a sensible routine of check-ins. They can also be agile in responding to events that could affect investment performance. For instance, the government’s autumn statements and budgets may include policies that affect investment-related tax allowances. Your adviser can provide prompt investment and financial planning support here if necessary.

These four investment principles can’t guarantee investment success. Even so they can, at least, help ensure you don’t overreact to market movements and face any unfortunate consequences.