There has a been a lot of turbulence in markets this year, reflecting wider geopolitical and economic risks. Some investors are concerned about the prospect of a stock market crash. Others think that markets could move even higher from here.
In reality, nobody can ever time a stock market crash with certainty. Just because the market looks like it should (or should not) crash does not mean it will.
Instead, the question I want to look at here is what a crash (whenever it might come) might mean for a Stocks and Shares ISA.
In this example, I imagine one currently valued at £20k. In practice, most of the same considerations would apply for a bigger or smaller ISA than that too.
A painful paper loss
A stock market crash is commonly defined as a fall of 20% or more in a short period of time. Reducing £20k by 20% would mean it becomes £16k.
However, that does not necessarily mean that someone with a £20k ISA would see its value fall to £16k during a crash.
That 20% figure is for the whole market. So, if the ISA is invested just in FTSE 100 trackers, it may fall by roughly that amount.
But for an ISA (like mine) that is spread across a wider range of shares, the percentage loss may be greater or smaller. Even in a stock market crash, some shares can do well thanks to their defensive qualities or outstanding business performance.
Others, meanwhile, can be hit harder than the wider market. Banks during the financial crisis were one of many examples over history.
That helps explain why it is always important to keep an ISA diversified.
What exactly is this loss in value, though? It is what is known as a paper loss. It only becomes an actual loss if the investor sells the shares.
Over time, a share may recover its paper loss – and perhaps ultimately move higher.
That is not guaranteed to happen. But in a crash, if I continue to believe in the investment case for a share I own, I typically just hang onto it in the hope of price recovery, even if it shows a paper loss.
Don’t forget about dividends!
Still, a paper loss can be painful for an investor when they see it.
What about dividends? They are never guaranteed – and a crash often sees some companies cutting or cancelling theirs altogether.
But some companies keep on paying out. Plus, lower share prices during a stock market crash can actually mean a buyer earns a higher yield than they would have months before.
One share that maintained its dividend during recent crashes is British American Tobacco (LSE: BATS). In fact, the Pall Mall manufacturer has grown its dividend per share annually for decades.
Smoking’s addictiveness gives tobacco shares some defensive qualities, as customers tend to keep buying even when the economy struggles.
Set against that, though, is the long-term decline in cigarette use. That has been eating into British American’s revenues and I see a risk they will keep falling. Some investors may also shun the tobacco share on ethical grounds.
I do see this as a share to consider. It has strong brands and has proven highly cash generative. The dividend yield is 5%.
Should you invest £5,000 in British American Tobacco P.l.c. right now?
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Christopher Ruane has no position in any of the shares mentioned.
