As you watch markets bounce about, it’s easy to let the voice of fear creep in and start to wonder if you might actually lose all the money you’ve invested.
It’s an understandable concern. If the UK stock market can lose about 30% of its value in a week, surely it could lose all of its value in a month? It’s easy to panic when the news is all bad and you don’t have a pot of cash under the bed.
Let’s go back to basics
When you own stocks and shares, you own part of a company. The share price, in the long term, reflects the value of that company and the amount other investors are willing to pay to be owners of it. This price may go up and down, but the share price for a strong company doesn’t go to zero. A share price essentially only goes to zero when a company goes bust.
If you’re only holding the shares of one or two companies, then it’s entirely possible that you could lose everything if they went bust. This is particularly true if you’re invested in small companies with just one or two product lines and the market for those products dries up. But it can also be true if you’re invested in a larger company that takes on excessive debt, or is poorly run – Thomas Cook is a recent example.
It was also true in the technology bubble of the late 1990s, when lots of investors bet heavily on companies with minimal sales just because they were attracting ‘clicks’.
Have a look at your underlying investments
Unless you’re an adrenaline junkie or a day trader, you probably aren’t invested in just one or two companies.
If you have a workplace pension plan, your money is very likely to be diversified across a range of investments through funds. These funds are either ‘active’ (where a fund manager picks the investments which they believe will outperform a particular sector, market index or other benchmark) or ‘passive’ (which aims to track the performance of a benchmark such as a market index like the FTSE® 100*). Both types of fund will hold a very broad spectrum of different investments.
Let’s take the example of a FTSE® 100* Tracker fund, as many people may be invested in something like this through their pension or ISA. For the FTSE® 100 Index* to go to zero, the 100 largest companies in the UK – including BP, GlaxoSmithKline, BT, ITV, Ocado, Unilever and Diageo – would all have to go bust at the same time. That’s extremely unlikely to happen.
Most active investment funds will also include a range of different holdings, usually between 30 and 80 companies, bonds, properties or other types of investments. Again, the likelihood of all of these going to zero is, in reality, extremely unlikely – particularly if they’ve been chosen by a fund manager for their long-term potential.
There have only been a handful of occasions where funds have seen catastrophic losses. And these have generally been funds focused on a single sector: for example technology-focused funds during the technology crash of the early 2000s, although remember that past performance isn’t a reliable guide to future performance.
The power of diversification
Diversification means that the weakness of any one investment will have less impact on your overall returns. It’s similar to a team – if you have lots of players in your team and one gets sick, it’s not the end of the world.
People can lose money over the long term if they focus too narrowly on one or two sectors or investments, rather than holding a broad spectrum across different geographic regions.
The coronavirus shows this very clearly. It came out of the blue, its impact is entirely unpredictable and it will hit otherwise healthy companies. An investor who had decided to back companies in the leisure sector, such as corporate entertainers or airlines, without a back-up plan could be looking very vulnerable today. But those with a broad mix of investments will be better placed to weather the storm.
So the answer to the question ‘could I lose everything?’ is technically yes, but it’s more likely if you’ve bet everything on only one or a very small number of things. As long as you’re sufficiently diversified, you may see a temporary hit, but you’re very unlikely to see your savings evaporate.
Where to find out more
If you want to find out more about where the funds in your pension or ISA are invested, have a look at their factsheets. These will give you a breakdown of their holdings, and may help give you some comfort about longer-term prospects.
If you’re a Standard Life customer, you can download fund factsheets from www.standardlife.co.uk/funds.
Want more information?
For further guidance and support about how the impact of coronavirus might affect your pension or investments visit the Pensions Advisory Service website.
* FTSE International Limited (‘FTSE’) © FTSE 2020. ‘FTSE®‘ is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under licence.
The information in this article should not be regarded as financial advice. Please remember that the value of investments can go down as well as up and may be worth less than was paid in. Information is based on Boring Money’s understanding in April 2020.