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Making an investment - fasten your seat belt

09/07/2019

We’ve all been on an aeroplane when there’s that familiar ‘bing-bong’ sound, and you notice the sign indicating you should fasten your seat belt. There’s an hour until you’re due to land, so wonder why you’re being told to fold away your tray.

The captain introduces himself, with that indistinguishable voice, and tells you that there may be some turbulence ahead. They assure you that as a safety precaution you should fasten your seat belt.

Once the risk of turbulence has passed, the cabin crew return to promoting their in-flight goods and the all clear is confirmed by the extinguishing of the seat belt light.

There are a number of similarities with investments, and in particular, stock market turbulence.

Often there can be a number of indications that there may be some turbulence ahead, and just like an aeroplane, its best to be safe. But whereas on an aeroplane we have lights to tell us when to fasten up, with investments we don’t always have this.

You’ll have noticed with the aeroplane analogy I’ve refrained from using words such as ‘drop’, ‘correction’ and of course ‘crash’, as clearly they have different meanings when it comes to investments.

So what’s the difference between a drop, correction and a crash ?

In short, when it comes to investments it depends on the size of the fall.

Drops, corrections and crashes are semantics, but as a guide, a drop is something that normally happens several times a year. A correction is generally seen as around 10% and implies that the prices of the investments were overvalued and that the price has now corrected itself. A crash however, is a significant fall, generally over 20% and can happen suddenly with no gradual build up.

Here are some points about to what you should do if there’s some turbulence in investments.

  • Do Nothing

Selling when prices have fallen is the worst thing anyone can do. Don’t sell, just sit tight.

More often than not, markets have a quick upwards movement after a crash, this is called a ‘dead cat bounce’. Don’t be fooled, this is still not the time to sell.

  • Ignore the voices in your head.

Warren Buffet once said “an unsettled mind will not make good decisions”. With 24hr rolling news, social media in the palm of your hand and a bombardment of information, you must remain calm.

Resist the urge to call your adviser and say “sell everything, I don’t care if I lose money, just get me out”. These are emotional reactions to a factual event.

  • Remember markets have always recovered

Investment markets are made up of real businesses, and these businesses and the real people (like you and I) who work for them, are here to sell goods and services to you and everyone else. Going forward, you still need to buy food, groceries, utilities, petrol and continue to live day in day out, and these businesses supply the goods and services to you for you to buy. Life goes on irrespective of what happens in global markets.

According to Capital Research and Management Company, below is the average time investment markets fall for.

 

Percentage Decline                  Average Frequency                   Average Time                           
5% + Around 3 times a year 46 days
10% + Around once a year  117 days 
15% + Around every 3 years 275 days 
20% + Around every 6 years  425 days 

 

Data Source: Capital Research and Management Company 

 

Investments rise and fall, it’s the very nature of investing itself, so be prepared. Typically, it takes a stock an average of 121 days, or four months, to recover from a correction. If a downturn becomes a bear market, (which is when stocks fall 20 percent or more from a high), it takes an average of 22 months, which is less than two years, to recover.

(Source CNBC Greg McBride 19th Dec 2018)

  • Go Shopping

This may sound bizarre, but stocks are cheap after a fall. It’s like going to your favourite retailer and seeing everything reduced in price. Another Buffet quote is “Be fearful when others are greedy and greedy when others are fearful". If you can afford it, have all your dividends re-invested as this is a great way of accumulating more assets at a cheap price.

  •  Stay Focused

You should have a well balanced portfolio with cash assets, short and medium term cash deposits as well as some guaranteed investments. These allow you access to monies whilst you ride out the storm. There was a reason why your adviser placed monies in cash, and this is it.

Your monies in the investment markets are part of your longer term financial plan, so keep focused on the long term goal. Ben Graham (an investment guru) often quoted maxim is true: 'In the short run, the market is a voting machine; in the long run, however, it becomes a weighing machine.'"

So is there going to be a drop, correction or crash ?

Yes, no and maybe.

Nobody has a crystal ball and just like each of the crashes that have happened in the past, everyone is wise with the benefit of hindsight. Markets rise and markets fall, and we are probably due something soon, but nobody knows whether it will be in three months or in three years.

I’ve been saying to my clients for the past 12 months, that nothing has happened for some time now and that worries me, because something should have happened. I think something has to happen, purely because history has a habit of repeating itself. Whether the spark will be a terrorist attack, another banking crisis, an trade dispute, a war, nobody knows.

There will always be the prophets of doom declaring ‘the end is nigh’, as there will always be those who in blissful ignorance proclaim the ‘streets will flow with milk and honey’. Personally, I’m in the middle, and always take my clients monies seriously being mindful of both what my clients have been through to receive their awards and my three decades of experience.

When I look at my clients’ portfolios, I always ensure the following:

  • They have enough capital in cash to meet any shortfall between their income and expenditure
  • They have enough capital in cash for any planned capital expenditure on the horizon
  • They have enough capital in cash for any unforeseen expenditure or emergencies
  • They are happy with their attitude to risk and that the portfolio matches that risk
  • Their portfolio is well diversified with a mixture of asset classes
  • Their debts are minimised or cleared
  • They are claiming all the benefits which they are entitled to, to maximise income

 

Should new investors be nervous ?

Certainly not. Any falls in markets present excellent buying opportunities where assets that will form the bedrock of a portfolio are being purchased at a cheaper price.

Remember the rule of investments, Buy Low - Sell High.

A client with a well-diversified and actively managed portfolio will be better placed for long term gains from their capital and can actually benefit from market uncertainty. In every event that has ever happened, markets recovered and went far beyond where they started. Stocks have survived wars, depressions, recessions and numerous corrections in the past, and will continue to in the future.

Whether we have a fall in markets or not, it should be remembered that settling a claim with the inclusion of a Periodical Payment removes a significant amount of investment risk. Whilst the periods of volatility may be short lived, they can however cause some concern. The guaranteed, tax free and suitably indexed security of a Periodical Payment should always be considered.

 

Article by Neil Brownhill 

Please note the views expressed in this article are those of Adroit Financial Planning. 

 

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