With markets around the world continuing to fall, investors are faced with two primary questions; should I sell out and when should I start to buy again?
At the outset, let me emphasize that the answer to these questions will largely depend on your investment timeframe, but allow me to approach things from the viewpoint of a conservative long term investor. Let’s address these questions one at a time, starting with knowing when to sell.
Unlike shorter term investors, I would argue that you only ever consider selling if the long term prospects of the company in question have changed. The near ubiquitous negative sentiment that pervades the stock market at present will act to send almost all stocks, good and bad, into the red. But if the underlying fundamentals of the business remain solid, long term investors should ignore shorter term volatility. After all, until you sell your losses are merely paper losses. And if your companies are likely to bounce back, and continue to pay good dividends along the way, it’s best to hold on.
If however you believe that your money could work harder for you in an alternate investment, then by all means you could switch your funds across. Just be sure of your analysis. Consider this; those that continually try to chase the winners will often underperform the broader market.
Take for example the investor that switches their funds into the previous year’s best performing sector at the start of each year. How do they compare with someone who simply invests in the market average (i.e. the ASX 200 index.)
Table 1. Best Performing Sectors on the ASX
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Figure 1. Chasing the winner: Investing in the best asset class of the past 12 months would have given you lower returns than the market average
As you can see, the strategy of chasing last year’s best sector has led to lower than average returns. I’d also point out that the returns have been more volatile, and you would have also faced higher transaction costs with all the buying and selling.
There is something else to consider. People exit the market to remove their exposure to the worst market drops, but it’s a two way street. You also miss out on any good days. To quote some research done by Colonial; if you missed only the best 10 days over the last 10 years, your average annual return would drop from 10.7% to just 6.8%.
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What I find interesting is that of the best 10 days, 8 of them occurred this year. What is also surprising is that of the 10 worst days, only 3 have occurred this year. Not what you would expect given the current meltdown of world markets.
The next consideration is knowing when to buy. Of course we would all love to able to buy into the market at the absolute low, but again we are faced with difficulty of consistently and accurately doing this. As usual, it’s a pragmatic approach that is needed.
At present there are plenty of good stocks that are currently trading at discount levels. Of course a slowing economy, higher funding costs and reduced consumer sentiment will mean that even the best companies experience somewhat of a slowdown, and things could stay tough for a while yet. But the solid blue chips will live to fight another day, and over the long term they will continue to perform well for investors.
With the benefit of hindsight we will always be able to say what we could have done better, but that’s a waste of time. (With hindsight I could say what lotto numbers I should have picked!) If we accept that economies and markets move in cycles, and that solid, established industrial companies have always performed well over the long term, we needn’t be concerned that the outlook is a little bleak at present. The fact is, the longer term investor can take advantage of all the pessimism and uncertainty and buy into some solid stocks at bargain basement prices.
Warren Buffet, the world’s most famous and successful investor, once said “Be greedy while others are fearful and be fearful while others are greedy”. Good advice indeed!
Make the markets work for you