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.
----------------------------------------------------
Ray Prince is an Independent Financial Planner with
Rutherford Wilkinson plc, and helps UK Resident Doctors and
Dentists get the best deals on mortgages, protection and
investments, as well as helping them achieve their
financial objectives. Just visit
http://www.medicaldentalfs.com to get your free retirement
planning guide. Rutherford Wilkinson plc is authorised and
regulated by the Financial Services Authority.
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