The month of May proved to be very volatile in the financial
markets. At the beginning of the month global stocks rose
sharply, some attaining record highs and then around the second
week came a mini-crash, affecting not just stocks but also
energy, gold and other metals, all of which had produced heady
profits for investors over the past couple of years. Even
the Rupiah became volatile. But then came a swift recovery
for just one week before markets tumbled once again before
the end of the month. The main reason for the initial falls
was fear of inflation and further interest rate rises in the
US. At the end of the month a report showing falling US consumer
confidence led to more selling.
Should this worry the long term investor?
Not at all. An experienced, long term investor will know that
rises and falls, surges and crashes are part and parcel of
the normal cycles of the financial markets. Over the long
term the markets can be relied upon to rise and to hold or
increase their values against inflation. Unlike money in the
bank which loses its value in real terms over time. It would
be nice if we could time the markets and always sell high
and buy low. In practice, market timing is rarely successful.
No-one could have predicted the daily direction of any of
the markets in the past month. This does not mean there are
no opportunities to take advantage of volatility. A shrewd
investor will take profits and reallocate funds when a particular
asset is clearly riding high. Finding the peak is impossible
but if you have already made a good profit does it really
matter if miss out on a little bit more? Far better to put
in the bag the winnings you have made, rather than risk seeing
them all suddenly dissipate. For several months I have been
recommending to my own clients that they take profits in gold
and energy funds that have soared between 100% and 250% over
three years. Not cash in completely though, since these sectors
are still good for the long term. Land and property
owners in Bali and elsewhere may see a similar picture. If
you own just one house it would not make sense to sell it
and take the profits if you were left without a house at all,
but if you own several and have seen big increases in value
then the same principle applies as to any other investment.
Take profits while they are still there. One day they may
not be!
No-one likes to see big dips in one’s investments
Indeed, even if one accepts that volatility is part and parcel
of investing nobody likes to see his or her financial investments
fall by 50% or more, which was the case during the 2000 to
2003 bear market. Such losses were universal at the time since
the conventional wisdom was that the majority of one’s
money should be put into the stock markets. This is not the
case today if your money is managed by a progressive wealth
management company. A modern portfolio will have less than
50% in stocks. The balance will comprise a diverse basket
of assets including government bonds, commercial bonds, emerging
market bonds, hedge funds, commodities and commercial property.
As the assets are not all correlated it is extremely unlikely
that all would fall at the same time.
Money can even be made from falling stocks
Falling stock prices may be bad news for most, but incredibly
there are ways to make money in this situation. A fund manager
for example, instead of buying shares in a particular company
will actually borrow them (for a fee) then immediately sell
them, only to repurchase them and return them to the original
owner when the prices are much lower. The difference in price,
less fees and expenses, becomes the profit for the fund and
its investors. Such a strategy is known as ‘going short’
or ‘shorting’ a stock. Some hedge funds are very
successful at this and can combine going long and short at
the same time with different stocks. Of course, if they get
it wrong in either or worse, in both cases, then the fund
could be looking at heavy losses. Do not try this at home!
Such strategies are best left to the experts with no guarantee
that even they will get it right.
Volatility is great for savings plans
While a lump sum investment should contain a diverse basket
of assets to dampen volatility, different principles apply
to long term savings and pension plans. In the early years
volatility can work in your favour. If you are making regular
contributions you will be buying more shares or units every
time the prices fall and fewer units when the prices are high.
Over time this will mean the purchase of more units than if
prices were rising steadily. This is known as dollar (or any
other currency) cost averaging. The secret here is to judge
the right time, after a few years, to switch into more conservative
funds and lock in the gains already made. New contributions
however can continue to go into more volatile funds. This
is known as the separation of ‘old’ and ‘new’
money.
To summarise, volatility is not something to fear, provided
that it is properly understood and managed. As you can see,
it is also possible to turn volatility to your advantage.
An inexperienced investor will panic when prices are volatile;
an experienced one will not lose any sleep!
Colin Bloodworth is a senior financial adviser with Financial
Partners International. The opinions expressed are his own.
If you have any questions relating to personal finance you
may contact him at 021 520 8099 or
colin.bloodworth@financial-partners.biz
