The Dow is off ~25 – 30% this year.
Trump has banned all travel from Europe, with the exception of the UK.
Sporting seasons are being cancelled, the Olympics might even be next.
Nobody appears to be immune from the Corona Virus (COVID-19), with politicians, sports stars, actors and everyday people contracting the virus. What a difference just a couple of weeks can make to the market. Many of us will have heard the expression from Warren Buffett, to be “fearful when others are greedy and greedy when others are fearful”, but what exactly does it mean and how do you put this into action when we’re experiencing a market downturn such as this one, and witnessing hysterical human behaviour such as the hoarding of toilet paper.
This week I would like to take the opportunity to highlight five of the worst mistakes that you can make as an investor during a market downturn. Let’s dive right in.
- Pausing or cancelling your regular investment plan
Many Australians, both expats and residents, whether it be through their superannuation or other regular investment plan, will be contributing a set amount or percentage of their salary on a regular basis. Based on relatively simple mathematics, by reducing or cancelling your monthly investments during a market downturn such as this one, your long term results are typically going to be much worse, as your average price will be higher.
Let’s consider a simple example. Assume that you’re contributing $5,000 per month into your investment portfolio, and to keep the illustration simple, we’ll assume we are investing all of these funds into a single Exchange Traded Fund (ETF). Now let’s look at a comparison between Jim & Margaret. Jim ignores the effect of the virus on his investments and stays the course, while Margaret panics and cancels her investments deciding to wait until she feels more comfortable. Let’s consider the average cost of investment for each of them.
As you can see in the tables above, Jim continues investing $5,000 every month and his average cost per unit of the ETF is $43.91, as he took advantage of the cheaper prices. Margaret, however, concerned that the world as she knew it was swiftly coming to an end, suspended her monthly investments for 7 months, missing out on the cheaper prices. Her average cost per unit ends up being $49.98, nearly 15% higher than Jim’s.
The key takeaway here is not that you should ignore everything that is going on in the market, however it is important to stay the course, and if possible, even look to increase your monthly investments when it feels least comfortable to really take advantage of the lower prices.
- Trying to pick the bottom…and getting annoyed when you don’t
Unfortunately, the only way to pick the bottom of the market is to buy consistently throughout a downturn and rest assured that one of your purchases will have been at the bottom. The most important part is to buy and invest in quality businesses when they represent value and you or your investment adviser considers them to be ‘cheap’. Expecting that you’re going to be able to pick the bottom, or getting frustrated when you find that the share price falls even further after you invest, is a fool’s game.
Consider Wesfarmers (WES.ASX), a well-known and loved Australian institution trading on the Australian Stock Exchange (ASX). During the Global Financial Crisis (GFC), the stock price got as low as $10.79 after trading at $28.00 just weeks before. Back then, I was an investor at $15, $13 and even $12.00. The most recent close, even after the impact of the virus, was $37.85. Do you really need to be considered about whether you bought in at $10.79, $15 or $12, when you’re up over 250% on your investment..?
The key message here is to invest in quality companies and strategies at prices that you believe to be cheap, and if they get even cheaper then consider buying some more. It doesn’t need to be any more complicated than this.
- Changing your risk profile in a panic
A common reaction to a market downturn is to look to shift your investment portfolio to a more conservative risk profile. This means reducing your exposure to growth assets and increasing the allocation to defensive assets such as cash and bonds. This is often a disastrous mistake, as it means that when the markets do recover, and you’ll find over time that this is the case following each downturn, you won’t enjoy the benefits of the rebound as you will have reduced your growth exposure. The long-term impact of this is a significantly lower annual return.
It’s important to continually monitor your asset allocation and rebalance when appropriate, during both the good times and the bad, and to stay the course. Reducing your risk profile now, with a view to increasing it when you feel more comfortable, will often mean that you’ll miss a significant portion of the bounce, as it never feels comfortable at the bottom.
Consider the above scenarios from the Global Financial Crisis (GFC). Three investors constructed a portfolio with $100,000 at the end of 2007. The first stayed the course and by 2014 had a balance of $143,550. The second decided that the sky was falling and it was time to cash in his portfolio while he still could and had a balance of $54,558. The third decided that it was a bit too scary and that he would buy back into the market when he felt more comfortable. As I mentioned, it never feels comfortable when it’s the best time to be buying, and as a result of this has a balance of $93,527 or over 6% less than he started with despite the significant bounce in the market.
- Spending more than you earn
This one sounds so very obvious, however it can be particularly financially devastating during a market downturn. If you’re consistently spending more than you earn, and living beyond your means, then this may mean that you have to ‘cash in’ some of your investment portfolio, which could very well be at the worst possible time. This can be particularly true during a market downturn, and the fear of not having enough to cover your over-spending can also lead to becoming spooked and selling off your investments at a bad time.
As always, you should have an emergency fund of 3 – 6 months of your living expenses accessible at all times in cash, as well as living within your means and spending less than you earn. This way, you will have the peace of mind to stay the course with your investment portfolio, and potentially even have excess cash available that can be put into the market when you and/or your investment adviser feel that it’s the right time to do so.
- Getting sucked in by FOMO – Fear Of Missing Out
As the expression goes, “fools rush in”, and this is particularly highlighted by stock markets, with the first decline typically not being the last. We saw this quite clearly on Friday 13th March on the Australian Stock Exchange (ASX), with the All Ordinaries (All Ords) declining approximately 6.7% in early trading and closing the day up 4%. Personally, I believe this being largely driven by investors fearing that they were missing out on the discounts and rapidly seeking to jump into the market.
It is this sort of irrational behaviour and decision making that has led to toilet paper shortages, armed robberies for hand sanitiser and toilet rolls and all new levels of ignorant racism across the globe. It’s important to be disciplined about your investment strategy, both in bull and bear markets, and this will allow you to sensibly take advantage of the volatility. This may mean setting target prices for your investments with your Adviser or by yourself, and maintaining the discipline to execute the orders unless something has materially changed when those levels are reached.
It has been some time since we’ve seen equity markets on sale, and I for one will be looking to take full advantage of it. Knowing full well that I can’t predict the bottom, but knowing that in the years to come, I will look back on this period with gratitude in knowing that I trusted my instincts and took advantage of the volatility even though it may not have felt comfortable at the time.
If you have any questions about your portfolio, or you’re concerned about the impact of the virus, or simply want to discuss what opportunities we’re currently exploring in the markets, feel free to reach out to me here.
To Your Financial Success!
Jarrad Brown is an Australian-trained and qualified Fee-Based Financial Planner with Australian Expatriate Group of Global Financial Consultants Pte Ltd providing specialist financial advice and portfolio management services to Australian professionals in Singapore. Jarrad Brown is an Authorised Representative of Global Financial Consultants Pte Ltd – No: 200305462G | MAS License No: FA100035-3
Australian Expatriate Group is a division of Global Financial Consultants in Singapore providing specialist advice to Australians living abroad.
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General Information Only: The information on this site is of a general nature only. It does not take into account your individual financial situation, objectives or needs. You should consider your own financial position and requirements before making a decision.
*Please note that Jarrad Brown is not a tax agent or accountant and none of the content outlined here should be taken as personal advice. You should consult your tax agent and financial adviser to review your current personal finances and financial goals to consider whether this strategy is appropriate for you.