The correct strategy for a regular investor is to hang in there, take advantage of the low prices and wait patiently for prices to recover.
Think long term if you plan to invest in equity markets
If you were hoping to hear more about my ski holiday, I am afraid you are out of luck. Instead, I have decided to delve into a topic that is far more pertinent to your financial health in the coming year - the FTSE 100.
The FTSE 100 index of share prices (representing the largest 100 companies in the UK) performed well in 2010. A last gasp "Santa rally" on Christmas Eve helped it close at just above 6000 for the first time since May 2008, only four months before the devastating collapse of Lehman Brothers, when the index fell to 3512. If you had been smart enough to buy at this nadir value, when everybody else was selling, you would have made a whopping 71 per cent gain in just over two years. In hindsight, it is pretty obvious to see what you need to do to make money: you buy when prices are low and sell when they are high. It's not rocket science.
But, for the life of me, I cannot understand why investors choose to do exactly the opposite. When prices were falling rapidly in Autumn 2008, many investors lost faith in equity markets and stopped their regular contributions.
"No point in throwing good money after bad" was a comment I heard many times.
The correct strategy for a regular investor is to hang in there, take advantage of the low prices and wait patiently for prices to recover. But 2010 has not been smooth sailing. In fact, equity markets have been volatile in response to a variety of events, including geological catastrophes, namely the eruption of an Icelandic volcano and BP's oil spill in the Gulf of Mexico.
Then there was the fear of so-called double-dip recession, the sovereign loan default by Greece and Ireland and the subsequent fear of contagion as it might spread to Portugal and Spain, destroying the euro on its way.
These events combined to send the FTSE 100 down to its lowest point of the year, at 4806, in July. With this kind of volatility, you can understand why investors are sceptical about equities as an investment asset class. But if your investment targets are long term, you should embrace this asset class, buy into the long-term trend and forget about short-term volatility. The UK stock market has absorbed all these events and related prophecies of doom and is now looking forward to a prosperous 2011. So should you.
Many analysts are predicting that the FTSE 100 will rise to around 6600 during the course of 2011. This is close to the long -term performance of the UK stock market, implying that 2011 will be an average year.
But the road ahead will be rocky and it is likely to be anything but average.
In an interesting article published on Citiwire (www.citywire.co.uk), Deborah Hyde identifies five threats to continuing global recovery.
First, there is fear about the Chinese economy and what its central bank will do to curb rising inflation. There are worries that this might rise even more as US policies to stimulate its own economic growth lead to higher prices for the metals and oil that are in such high demand by Chinese manufacturers.
If the Chinese authorities respond by lifting interest rates, economic growth is likely to decline and this will have a dramatic impact on demand for raw materials from overseas and, subsequently, on share prices in the UK and elsewhere.
Second, she identifies banks as a cause for worry. In 2010, banks fared fairly well, with only Barclays and HSBC shareholders sitting on losses. But a rise in unemployment will increase the risk that borrowers will default on their loans and this will make banks nervous about lending. The credit ratings agency Moody's, she says, has warned that declining government support and the need to refinance as much as £215 billion (Dh 1.2 trillion) adds to the negative outlook for this sector.
Third, there is European sovereign debt. Worries about Greece and Ireland were largely contained by the end of 2010 but could still spill over to other markets. The economy in Spain is much stronger than that of Greece, Ireland or Portugal, but some analysts believe that a banking collapse is not out of the question. Since the stronger European economies and Germany, in particular, are showing less enthusiasm for supporting the weaker economies of the European Union, there is a potential disaster looming.
Fourth, the US has debt problems of its own.
While other countries around the world have drawn up plans to cut their debt, the US has done nothing to tackle its US$14tr (Dh51tr) debt mountain. In fact, it has done the opposite - by announcing tax breaks and increasing spending on unemployment benefits. This will add to its deficit in the years ahead and has already sparked worries among investors. Moody's, Ms Hyde says, issued two cautionary warnings in as many weeks saying the US must say how it intends to reduce its debt.
And as interest rates rise, as surely they must, the cost of servicing the debt will increase further, thus limiting growth in the world's largest economy.
And finally, she identifies UK's inflation as a cause for concern. Whether you are a saver or an investor, the current high levels of inflation in the UK are already a problem. The buying power of your money is falling and most economists expect inflation to rise in the first part of 2011 as the 20 per cent VAT increase and higher oil prices take their toll.
Chinese and American policies could also add to upward price pressures and that could mean the Bank of England will not be able to bring inflation down to acceptable levels without lifting interest rates.
Bill Davey is a financial adviser at Mondial-Dubai. If you have any questions on this article or any other financial matter, contact Bill Davey at email@example.com