How not to invest in 2024

Markets were in a party mood at end of 2023. Global equities rallied 15% in November and December, the tenth highest two-month return for MSCI World since 1969, as investors eagerly anticipated that central banks will soon dial back interest rates in response to inflation subsiding. Yet this is far from a forgone conclusion and markets could be range bound until data validates their hopes.

Collectively investors consistently priced in too many cuts in 2023, repeatedly backdating their estimations for an interest rate ‘pivot’. With fresh dovish tones emanating from the US Federal Reserve in particular, rate cuts are again priced in heavily for 2024, but they continue to remain below the levels seen in the ‘dot plot’ that indicates the expectations of the decision makers, leaving markets at risk of upset.

Although markets may have got a bit ahead of themselves in pencilling in earlier and deeper cuts, investors also have a year of opportunity to look forward to. Continuing recovery from the scars of the pandemic, improving technology and falling inflation over time are all beneficial themes that provide the wider backdrop of whatever dramas lie ahead.

To help guide your thinking about the year ahead here are three important mistakes to avoid.

How not to invest in 2024

1. Don't take too much, or too little, risk

Investing is always a balance. Taking risk is necessary to generate an acceptable return ahead of inflation but take too much at the wrong moment and you can end up derailing your plans and making bad investment decisions. There are plenty of risks out there, and events may come along to test or disrupt this year with markets likely impacted by elections all around the world as well as new and existing conflicts. Yet at the same time there are great long-term opportunities and a well-thought out and diverse portfolio should stand investors in good stead.

When considering the inevitable ups and downs of investing, it can be easy to equate it with gambling, but that would be a mistake. In gambling there is, realistically, an expectation of a negative outcome. You might win some bets initially, but the more you do it over time the more likely you are to lose money. Investing is the reverse. It’s perfectly possible to lose money, and many people do, especially over short time frames or by focusing too much on a single stock or area, but over the longer term there is expectation of a positive outcome. That means longer you keep doing it the more likely it is that you will make money.

The problem is events, especially unexpected or ‘Black Swan’ occurrences, often cause investors to panic and sell out at just the wrong moment. Instead, it’s generally best to keep going, stay invested and adjust portfolios according to where a good balance of risk and reward lies. That could mean tilting more towards more risky areas at times but being more defensive at others, but ultimately having a portfolio that takes sufficient risk to secure strong long term returns but is sufficiently diversified so not to be reliant on a particular scenario playing out, or a small number of stocks or areas doing well.

One of the moves our multi asset fund managers have been considering recently is reducing the reliance on US equities generally and the so-called ‘magnificent seven’ technology stocks in particular. Collectively, these seven stocks rose 76% in 2023 while the rest of the world returned just 16% in what was probably the greatest concentration of equity returns since the 1960s. These giants now make up more of world index than Japan, the UK, China and France combined.

Reducing reliance on these stocks can be achieved by moving portfolios towards equally weighted indices where all constituents are the same size rather than the traditional, more concentrated market capitalisation-weighted ones. The team having also been introducing greater small and medium-sized company exposure where valuations are less demanding, notably through a position in UK midcaps.

2. Don't reach blindly for yield

Investors are naturally attracted to investments producing a high yield, the yardstick by which the income an investment produces is measured. Generally, this is the amount it has paid over the past year divided by its price, and it is expressed as a percentage, although some yield calculations are forward looking. However, a high yield is also a warning sign. There is likely to be a very good reason why it’s so much. For bonds, higher yield means higher risk and there is more chance of default and capital loss. For shares it may mean there is a strong chance that dividends, the pay outs to shareholders, are going to fall rather than rise.

This is especially relevant at present as the rising interest rates of the past couple of years are creating corporate winners and losers. Those with low levels of borrowing, or even net cash on their books, are in a strong position, but for those renewing lots of debt at current levels there may be trouble ahead if economic challenges results in a company being unable to service or repay debts.

We are therefore somewhat wary of the riskier high yield end of the bond market where defaults are more likely to arise, and for exposure we prefer active managers who can selectively choose undervalued names and avoid those that might suffer through a recessionary period. Meanwhile, for shares it means a focus on quality and strength is important, as well as a need to harness enduring structural growth themes. As always, diversification by sector, geography and type of asset is wise to help reduce risk and ensure you are not overly reliant on one area or on certain circumstances.

3. Don't be 'absolutely' wrong (it's OK to be a bit wrong)

Football managers frequently say they learn more about their team from defeats than from victories. It’s a similar story when it comes to your portfolio. Investment errors are inevitable, and they can be helpful as they can reveal flaws in your approach, so it’s always best to embrace them and question how they might have been avoided.

Never forget that a result by itself tells you nothing about how it was achieved. A good gain might have been attained through careful, well-informed investment or it could have been a wild gamble. To expand the football analogy, a team might be fortunate enough to win the match with a speculative shot from the halfway line, but that’s not going to help with tactics against the next opponent.

Picking winning stocks is very difficult because, at the risk of stating the obvious, the future is uncertain. Uncertainty about how companies might compete, expand and adapt; industry changes, the effect of regulations; demographic trends; economic challenges – the list is endless. What you see each day with share prices erratically moving up and down is investors trying to grapple with these uncertainties and price them in. The world is challenging for companies to navigate and that is especially the case today as the pace of technological change and disruption is so rapid.

How can investors stand a better chance of winning? Falling back on another sporting analogy, rather like a successful tennis player it’s more about making as few mistakes as possible than it is about attempting spectacular, higher risk shots that impress the crowd. Avoiding the problem stocks and areas that result in permanent capital loss is more important than pinpointing all the winners – it’s far better to be about right through diversification and risk control than it is to be absolutely wrong.