This vote will have significant global economic impact. But because the referendum result itself is not a binding decision, it will take considerable time before that impact is fully felt.
In the interim, uncertainty will persist. First, the result needs to be incorporated into an Act of Parliament in the United Kingdom. Under the terms of the Lisbon Treaty (part of the EU’s governing framework), the United Kingdom will then give formal notice to the EU.
After that, negotiations will begin on the actual exit terms. Those negotiations can span two years and may be extended further.
Most financial markets, especially stock markets, don’t like uncertainty. In the weeks leading up to the vote, speculation about the outcome triggered increased market volatility—especially for most assets denominated in British pounds.
Market volatility and investor uncertainty
Once the results were in, global markets and the British pound traded sharply lower. On the face of it, these gyrations might tempt investors to make dramatic shifts in their portfolios, especially moving away from assets perceived as riskier.
Of course, Vanguard discourages market-timing, which is so often counterproductive. The bottom line is that avoiding or reducing specific investments might not achieve the desired result. Also, much of the effects of the vote are now already priced into asset values.
Estimates of how Brexit will affect the U.K. economy range widely; some are positive, but the majority are negative.
Implications for the U.K. economy
A key assumption in any Brexit scenario is what happens to trade agreements. The EU is the United Kingdom’s largest trading partner, receiving about half of all U.K. exports. Upon leaving the EU, the United Kingdom will lose its automatic right to the favorable trade terms that EU membership bestows.
The International Monetary Fund (IMF), for example, projects that U.K. gross domestic product could drop more than 1% by 2021 under its most favorable scenario that assumes the United Kingdom will retain access to the EU market. Under a less optimistic scenario, the IMF projects that GDP could drop more than 4%.
Concern about Brexit already led businesses to put hiring and spending plans on hold, and it has decreased merger and acquisition activity. Less favorable trade terms could also discourage foreign investment in the United Kingdom by firms that might otherwise seek a U.K. presence to access European customers.
Immigration policy has been one of the major issues in the Brexit debate. Although it will still be possible after Brexit for EU citizens to work in the United Kingdom, such decisions are likely to rest with the U.K. government—in contrast to currently unrestricted access.
Suffice it to say that a whole host of new U.K. regulatory frameworks need to be developed to conduct business and trade in a post-EU world.
Given that it may take several years for the specifics of Brexit to play out, and markets may continue to experience volatility as plans take shape, investors’ best protection is to hold a portfolio that is diversified across asset classes and regions.
Implications for investors
In Vanguard’s diversified balanced funds, such as our Target Retirement Funds, we will continue to maintain global exposures that are consistent with the funds’ investment objectives and policies. Although it is certainly worthwhile to keep abreast of global events such as the Brexit referendum, we caution investors against making tactical or short-term changes to their portfolios.
Instead, we recommend following Vanguard’s four core investment principles: create clear, appropriate goals; develop a suitable asset allocation using broadly diversified funds; minimize cost; and maintain perspective and long-term discipline.
All investing is subject to risk, including the possible loss of the money you invest.
Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
Investments in bonds are subject to interest rate, credit, and inflation risk.
Diversification does not ensure a profit or protect against a loss.
Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.