Investors have suffered a shocker over the last few days as fears about slowing growth in the powerhouse that is China dragged down global stock markets. It’s par for the course that if you want to be in the markets, you have to take the rough with the smooth. Yesterday saw a bit of a rebound from the sharp falls seen on so-called ‘Black Monday’ (not to be confused with Black Friday, which is mainly about fighting over flat-screen tellies), but some market commentators are predicting things could get worse before they get better.

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A lot of professional investors have been expecting to see a stock market correction for some time. After all, all that easy money pumped in through central banks’ quantitative easing programmes had to come out in the wash at some point. China isn’t helping things by rushing out a fresh rate cut to try to counter hefty market falls – the market needs to be allowed to find its natural level, as convincingly argued here by Hargreaves Lansdowne’s Mark Dampier.

The Independent published five charts yesterday which basically illustrate that the volatility we have just seen isn’t the end of the world. They are definitely worth a look.

Anyway, the point I want to make is that, as painful as it might be to look at your portfolio this week, there’s no need to panic. The smart investors will have been buying on the (big) dips to pick up the stocks they like at bargain prices, and sticking with their strategy. Hopefully this will include buying good quality businesses which will continue to trade and grow and do what they do, regardless of what’s going on in China’s economy.

A lot of fund managers have learnt lessons from previous market volatility, and are happy to diversify into other areas around the edges of their portfolios, whether buying a few small and mid-cap businesses to supplement their core large-cap holdings, or using the maximum allowed weighting to overseas stocks, so their holdings are less likely to fall together during market sell-offs.

If you put the falls of the last few days into the context of a 30-year investment time horizon, it will look like nothing more than a little blip. But this latest wobble won’t be the last, which is why pound cost averaging is a sensible strategy. What is it? All it refers to is drip feeding money into the market regularly rather than putting in a big lump sum, whether by buying units in a  fund or buying direct shares. In this way, you can end up buying more shares when they are cheaper, and fewer as prices rise, evening out the market’s ups and downs.

Morningstar has explained this better than I can with a clear example:

“Let’s say you have £1,200 in cash to invest. Rather than invest all £1,200 at once, you could invest £100 per month for a year. Now let’s say the fund you’re investing in sells for £10 a share in the first month but drops to £5 a share in the second. Using the pound-cost averaging method, you would end up buying 10 shares in the first month, before the market drop, but 20 shares in the second, after the drop. Had you invested the entire £1,200 in the first month, you would have owned 120 shares, which, in month two, would have declined in value to £600. In this way, pound-cost averaging helps reduce an investor’s exposure to a potential market downturn.”

Here’s another vote for pound-cost averaging from Nigel Green, CEO of advisory firm deVere Group. He emphasised how important it is to have a good spread of investments across different regions, asset classes and sectors – in other words, don’t put it all on black 13. But he also explain why regular investment over the long term is so important.

It’s nearly impossible to predict what the stock market is going to do in the immediate future – and it is much too early to say if the current sell-off is nearing its bottom.

Stock markets tend, over time, to go up over multi-year time periods. With this in mind, a sensible strategy is [pound] cost averaging.

Investors need to ask themselves ‘will stock markets be higher than this when I retire? Looking at financial market history, the answer is probably ‘yes’, if they have a decade or more ahead of them. So, logically they should carry on buying as markets fall.

It is best to just feed the money in over time in a measured way in order to take advantage of the long-term trend of stock markets to deliver long-term capital growth. History teaches us that panic-selling in stock market crashes can be potentially financially disastrous for investors.

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