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Our last editorial discussed the issue of keeping ones savings in times like these when cash flow is tight. We emphasized the point that the earlier you start and the longer you keep with your savings plan the bigger the compound effect and the fact that money seeds planted today will reap a handsome harvest in the long run. Yet over the last couple of weeks we saw a downturn in the stock market and anybody with an investment portfolio would have experienced a 10 – 12% loss from values of 6 weeks ago. This raises the question: Should you cash in and run for cover or sit tight?
This question should be answered with another question: when will the money be used? Now this is not to be like an economist and sit on the fence but the fact of the matter is that the investment horizon should be a determining factor in where the money is invested and hence whether one should ride it out or not.
When one structures one’s investment portfolio you should, like anything in life work with a plan. An investment strategy is derived from the objectives and personal circumstances of the investor. If you don’t have a long term strategy and if your investment portfolio was structured without a proper plan then you will be jumping from one investment to the next and chances are that you will be losing money over the long term.
Asset classes have different returns and risks over the long run. Typically over a long term of 20-30 years, equities (shares of companies) have produced by far the best returns with an average return of over 20% per annum. On the other hand cash or money market investments have produced a return of just over 13% for the same period. Interestingly enough inflation over this period was close to 11%. Bonds and property’s returns were somewhere in between.
However, the road to these returns was very different. Whereas money market investments showed a smooth ride, investments on the stock exchange was very bumpy with major downturns in 1987, 1998, 2001 and lately.
So should equity investments be cashed in or not? This takes us back to the earlier question: what is the investment horizon or put in another way how long before the money will be used and what is your objective with your investment? The principle is this: the longer the term before the money will be used the more exposure can be taken to equities and there is no argument that over the long term equities produces the best returns. If you have time on your side you can ride out the bad times to enable you to share in the good times. Too often people try to time the market meaning they try to get out when the markets move down and get back in when markets go up, unfortunately most often to their own detriment. Research done a while ago showed that over a 10 year period you could have reduced your average annual return from 20% to a mere 1.5% if you tried to time the market and missed only 40 good trading days over the total period. That is why there is a saying in the investment arena, it is not about timing the market but rather about time in the market.
If you are going to need the money over the next two years then you should not have invested in the stock market in the first place unless you are a speculator. Funds that will be used over such a short period should rather be invested in cash. A typical money market account earns close to 12% at this stage so over the short term this is a good return and the capital is safe.
If you are not in the market yet and want to invest a lump sum an option may be to phase your investment in i.e invest 20% of the amount per month over the next 5 months. This way you reduce the risk of your capital losing a lot if the market keeps going down for a while longer.
If you are in the market however and your investment horizon is 5 years or longer then tighten your seatbelt and ride it out. History has shown that investors who were willing to stay in the market for long periods of time were rewarded handsomely.
If you are saving on a monthly basis then keep doing more of the same and don’t change your strategy or asset class now.
It is in times like these that we as investors should not allow our emotions to get the better of us. If we have a well planned investment strategy based on sound principles and researched assumptions, then one should stick to it.
One key principle when it comes to investments is diversification. By diversifying one can reduce the risk of one’s portfolio without giving up too much on the return side. This however is a topic for next time.
Keep your head up. Till next time!
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