FINANCIAL IMPLICATIONS OF BREXIT
The financial implications of Brexit could be considerable, so we have set out below the main short-term issues. In particular, we examine how Brexit could have an impact on your financial planning and investment management.
- There are risks to the economy ahead
- The main financial implications of Brexit
- The UK stock market
- The value of Sterling
- The risk of a recession
- What should you do about your investment portfolio?
What are the main financial implications of Brexit?
The main risks are those to the UK economy, caused by the uncertainty and protracted negotiations with the EU. This could lead to a number of scenarios, but possibly any of all of those set out below. These are all short-term reactions to the considerable constitutional and trading changes. They do not necessarily have a bearing on the long-term future of the economy.
The UK stock market
The stock market does not like uncertainty, which is why traders reacted sharply to the news of the vote to leave the EU. Trading was very volatile, but by the end of the day after the vote the FTSE 100 (the 100 largest UK companies) ended up 3.15% lower than the previous day. The FTSE 250 (which contains the next 250 largest UK companies) ended up 7.19% lower.
These are big moves, but are not unexpected given the size of the change ahead of us. To put these figures into context, the FTSE 100 is currently showing a gain of 0.60% since the start of the year. The Bank of England and Treasury have both moved to calm markets since the referendum result. In particular, the Bank of England has put up to £250 billion available to provide liquidity and stability into the market. The early signs are that this has had a calming effect, but only time will tell.
We expect that the continued uncertainty will bring volatility in stock markets, but there is always uncertainty in stock markets.
What should you do about your investment portfolio?
The financial implications of Brexit show the value of diversification in your investment portfolio. Our clients all have a widely invested portfolio, spread around up to 15 different asset classes. We do this to spread the risks, so that events in one area do not overly impact their investment returns. We cannot rule out that investments will not drop in value, but we can smooth out the worst of the volatility to come.
To show you how this can work, our model investment portfolios grew in value on Friday, when the UK stock market went down in value. This is because we wisely spread our clients’ money across a variety of sectors, and some of these rose in value. Of course, 1 day does not prove anything, and investments can fall as well as rise, but this shows the wisdom of keeping calm in volatile investment markets.
Performance of our model portfolios on Friday 24th June 2016:
- Cautious – up by 1.40%
- Moderately Cautious – up by 1.23%
- Moderate – up by 0.40%
- FTSE 100 – down by 3.15%
So, if you are a client, my message is that your portfolio should be doing what we expect – it insulates you from the worst of the stock market volatility.
If you manage your own investments, take some time to review whether you are over-exposed to the stock market. In my experience, most people who handle their own investments have too much exposure to the UK stock market. If this is your position, you may find a bumpy ride ahead.
Should you pull out of the market?
Now is not the time to remove yourself from the market. Clearly, the economy is going to move forward in the medium term, and your investment portfolio should be built around your long-term goals. No-one who can tell you with any reliability what is around the corner. If you pull your money out now you run the risk of consolidating losses, or missing out on the possible gains ahead. Of course, if you need access to your money for a short-term project then you may need to act differently, but if this is the case then perhaps you should not have been invested in the first place.
There is an important concept in investing called capacity for loss. This is an assessment of your ability to ride out any short-term falls in investment performance. When we review clients’ investments we always ask whether they need access to their money in the short-term, and whether any losses would impact on their standard of living. Ask yourself the same question, and this should be part of any investment decisions.
The value of Sterling
The financial implications of Brexit have been seen in the fall in the value of Sterling (the Pound) since the referendum result. This shows the initial market reaction to the result as negative on the UK economy. Like with stock markets, time will tell. On Friday, the value of the US dollar rose by 8.26% against the value of the Pound. This suggests that international markets see trouble ahead for us. However, we should remember that currency markets fluctuate all the time. Since the start of the year, the US dollar has risen by 7.73% against the Pound. What is particularly striking is that the short-term falls has been greater than we would normally see. This is not unexpected, given the shock of the EU referendum result.
What should you expect from a fall in the value of Sterling?
We import more than we export, so this could mean price rises for food and petrol in particular in the short term. The price of foreign currency has risen already, meaning that holidays will cost more this summer. It remains to be seen how this will pan out. Again, currency markets do not like change, so you should expect volatility for the next 18 months, and possibly longer while the financial implications of Brexit are worked out.
Financial planning – the emergency fund
An important provision in any financial plan is an emergency fund. This is an amount of cash you put aside in the event of emergencies, just in case it is needed. This should be easily accessible, and should be in addition to amounts needed for short-term projects like holidays, cars, tax bills etc. If you have an emergency fund, you can now dip into this to pay for the additional costs of currency fluctuations. If not, you should start to consider what you will do if the economic conditions get worse.
A risk of recession
The financial implications of Brexit are clear: most economic commentators predicted a worsening position for the UK economy should we choose to leave the EU. There will be protracted trade negotiations to leave the EU, which could take years, and there is a short-term political and constitutional crisis to manage. All this creates uncertainty, which in turn will likely lead to lower business confidence and investment. The Bank of England has already noted lower business investment (before the Brexit vote), and we should prepare for this to continue as businesses wait to see what happens. The longer and more difficult the trade negotiations, the more pressure there will be on the economy, which could lead to a recession. This could have short-term implications for your investments.
Investment Management – your investment term
When making decisions about your investments, you should consider the investment term. The basic theory is that if you will need access to your money soon, then you should take less risk, or no risk. If you do not need access to your money you should be able to ride out the volatility in the investment markets. You cannot avoid volatility unless you take no risk at all. Therefore, I do not believe you should withdraw your money from your investments just because of the threat of a recession. Examine your own position first, and make decisions based on your needs.
Financial Planning – life expectancy
Consider how long you expect to live (see this article). For many people, your investment term is not the next few years, but probably the rest of your life. Therefore, it makes sense to plan for the long term rather than make rash short-term decisions.
What should you do next?
Don’t take any rash decisions! Talk to us first and help to get some perspective on the overall implications of your choices.
Find out how we can help you to Prosper during retirement.
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