Stay Calm When the Bear Prowls

"Courage taught me no matter how bad a crisis gets ... any sound investment will eventually pay off." (Carlos Slim)

Hold onto your chips when the market dips

When stock markets fall, it’s very natural to want to sell your shares and invest in less risky assets like cash and bonds, in an attempt to avoid further loss. Doing this, however, locks in a loss forever. If your share portfolio falls by twenty percent (a normal occurrence in the course of investment cycles) and you sell, the loss becomes permanent – as opposed to a ‘paper loss’. Another important point is that if your investment drops in value and you sell, you need to achieve a higher return to get back to the initial value. For example, if your investment drops from R1 million to R800,000 and you sell out, you must achieve a 25% return to get back to your original value of R1 million. This is highly unlikely in the short term. Because no two investment cycles are the same, nobody knows when the markets will turn for the better – not even the smartest analysts. If you’ve sold out, you may very well miss out when the bull starts to run again. The bull is unpredictable and very fast: you can’t afford not to have a finger in the pie during the best performing days.

The proof is in the pudding

Still not convinced? Let’s look at some figures. The research company Morningstar did an analysis using the JSE All Share Index to demonstrate the difference in returns between an investor who decided to stay the course, and three other investors who missed out on the 10 best days, the 20 best days and 50 best days, from October 2003 to October 2018. The study assumed that all four investors invested R1 million in October 2003. At the end of the cycle:

  • The investor who stayed invested was worth R 5.4 million.

  • The investor who missed the 10 best days (by trying to time the market) was worth R 3.1 million.

  • The investor who missed out on the best 20 days was worth R 2.1 million.

  • The investor who missed out on the best 50 days was worth R875,000 – a loss of R125,000.

Isn’t it incredible what a difference a few days can make?

Phase in, or take the plunge?

Now that we’ve proven the importance of staying the course let’s move on to another important question. If you’re sitting on a lot of cash (you may have sold your holiday house or received a great bonus), should you phase in the investment over a period of 6 to 12 months? Or should you take the plunge and invest a lump sum in equity that has recently underperformed?

Phasing in may sound like a good way to minimise risk, but research by Sanlam indicates that phasing in is generally not a good investment strategy. Looking at the period from July 2000 to July 2015, Sanlam found that 83% of the time, a lump sum investment outperformed the phase-in method (for high equity shares). Of course, you do need to consider human emotions. If you can’t stomach the stress taking the plunge, phasing in is a far better bet than not investing at all.

Bulls and bears

Don’t make the mistake of trying to tame these two unpredictable beasts. The markets have always been cyclical – this is not going to change. Think back to the dips in 1929 (if you’re that old!) 1987 and 2008. Remember, that despite their cyclical nature, the markets’ long-term trend is always upwards. The best way to decrease loss (and thus increase the growth of your investments) is through a diversified portfolio that has been compiled by a qualified financial advisor.

The final word

History has a funny habit of repeating itself. And even COVID and the war in Ukraine will eventually pass. While it may be hard to watch your investment portfolio take a short term hit, you’ll do far more damage to your financial future by panic-selling and thus locking in your losses. If in any doubt, remember that your financial advisor is always only a phone call away.

Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.

© FinDotNews

7 views0 comments