At the time of writing this article the Markets are showing great signs of nervousness and probably should be on Prozac. The problem is that the Markets are uncertain as to the future and therefore have bouts of pessimism followed by optimism followed by pessimism again. Consequently, we see big swings in daily prices of securities.
At the time of writing this article the Markets are showing great signs of nervousness and probably should be on Prozac.
The problem is that the Markets are uncertain as to the future and therefore have bouts of pessimism followed by optimism followed by pessimism again. Consequently, we see big swings in daily prices of securities. We know that the main instigation for this has been the "credit crunch", which is a result of a lot of poor lending decisions and too much credit being made available to people who ultimately can't afford to make the repayments.
This has been particularly the case in the USA but the contagion has spread. I do not wish to belittle the importance of the lack of credit being available as we have seen the upset, uncertainty and fear that can be caused as the Northern Rock was a direct casualty of this.
That said, the Stock Market continually goes through cycles of good times and bad times. However, the thing to remember is that unless capitalism is completely broken it will recover.
We have seen this on numerous occasions from the period around the First World War, the Great Depression in the late 20s to early 30s, the Second World War, the crash of 1987 and, most recently, the bursting of the dot com bubble from January 2000 to March 2003. In every case, the Market recovered and recovered strongly.
I missed out one important period and that was in the early 70s when Ted Heath was struggling with the unions, the three day week and oil prices went through the roof. In 1973 to 1974 the Stock Market fell by around 70% but recovery the following year was even more dramatic with a rise of over 150%.
The point I am trying to make is that corrections will occur and there will be periods, sometimes extended, of negative performance. However, the economy and therefore the Stock Market will bounce back. The question now, therefore, is what do you do if you are already invested? In this case I would recommend that you review your portfolio to make sure it is in line with your long term aims but I would not recommend bailing out.
Why?
Because it is impossible to time the Market. Further, if you miss the good days by being out of the Market then you can miss substantial opportunities. As an example of this there is a study of the Dow Jones covering the first quarter of 1981 through to the end of the second quarter in 2003. It showed that if someone had been invested all through this period, which had good times and bad times, the annualised return was 10.4%. However, if an investor was trying to jump in and out of the Market to avoid the falls but missed the best ten days in that period, their annualised return would fall to 7.7%.
Similarly, if they missed the best twenty days then it would fall to 5.8% and the top fifty days of performance missed would reduce the annualised return to 1.3%. This means that the unfortunate "mis-timer" of the Market would have lost out on 86% of the total return if they had been out of the Market for the best fifty days for investment.
In addition, this does not take into account the costs of buying and selling. A buy and hold strategy is more efficient from a cost and ttax point of view. Consequently, it is important to get your choices right at the start.
The more cautious may think they would rather just stick the money under the bed but you must remember that inflation will continue to eat away at your money's real value. For example, the Government's target of 2% for Consumer Price Inflation means that your pound would only be worth sixty pence after twenty five years.
The Retail Prices Index is actually higher than this and is running at over 4% as I write, which means it would half the value of your money in around seventeen years.
The moral of this story is that if you are looking to invest you must be looking at long term horizons and not short term. You just be prepared to see some volatility in the values of your portfolio, but do not panic. Have the belief in what the Market can and has done consistently.
Looking ahead, I believe that there will be some bargains to be had. It is said of Aristotle Onassis, the Greek shipping magnate, that he made his fortune at the time of the Great Depression because he was one of the few people with cash and was able to buy his first fleet of ships at a tenth of their value. Whilst I do not expect that we are looking at a Great Depression or prices as low as Onassis found, I do believe that there could be significant value in certain arenas.
The Financial Tips Bottom Line
Understanding the key principles and fundamentals of investing is crucial when you are investing your money on the Stock Market. If you don't, then you run the risk of continually chasing the next big fund launch and incur additional costs when you buy and sell shares and funds.
Action Point
Don't make the mistake of underestimating the importance of leaving your money invested over the long term. And make sure you have the money invested in a suitable portfolio (NOTE: This is vastly different to a collection of funds that many investors have) using the process of Asset Allocation.
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