Keeping your cool is just as important an investment strategy when markets are tanking as when they’re booming.
It’s important to remember that what goes down eventually comes up again, just as what goes up eventually comes down. It may be hard to believe now, but history has shown that the economy and markets in times of recession do recover.
Andrew Beer, manager of strategic investment planning with Investors Group, said financial markets tend to start their recovery four to six months before recessions end.
During the 1980 recession, for example, the TSX composite index fell 39.2 per cent in the 12-month period that ended in June 1982. That’s slightly worse than the 38.2 per cent drop in the TSX in the 12 months that just ended in February 2009.
However, in the next 12 months that ended in June 1983, the TSX soared a whopping 86.98 per cent. The same trend has occurred in other recessions as well.
“Typically, markets start their recovery anywhere from four to six months before the end of a recession is announced,” said Beer. “This is promising news for people today. Markets are essentially forward-looking and act on news while recessions are backward looking. Hindsight is a wonderful thing.”
Beer said two main types of psychologies tend to emerge in investors when markets start to recover.
The first is the temptation to jump back into the market with both feet in the hope of making up losses as quickly as possible. While this might seem like a good idea, it actually could expose your portfolio to a great deal of risk because the upturn which is causing you to jump back into the market could be a temporary blip and might not be the real thing.
Other investors might be driven back into the market by fear — the fear of losing out on good bargains and picking up investments at a low.
“In turbulent times there will be good and bad reports,” said Beer. “The trouble is, no one knows for sure which is right. The best thing is to move slowly and surely and see what happens.”
Beer said investors need to stick with investment fundamentals in turbulent times and not get caught up in the emotion of the moment.
“You should look at your portfolio and see how it’s balanced,” he said. “If you have underweighted positions you might want to top them up. But don’t forget the reasons why your portfolio was built the way it was and don’t try to make up your losses all at once.”
Beer also suggested sticking with the basic strategy known as dollar cost averaging — investing regularly through a continuous savings plan regardless of the share price or market value. By doing this, more shares are purchased when prices are low and fewer shares are bought when prices are high.
Dollar cost averaging reduces exposure to risk associated with making a single large purchase and can protect investors from trying to time the market (buying at a low and selling at a high) by spreading investments over a number of purchases over a longer period of time.
Since the market has a positive mean rate of return, dollar cost averaging usually requires the investor to give up some returns for the benefit of reduced risk. It has an added advantage of letting the value of your investment compound over time.
“Stay diversified (with different asset classes),” said Beer. “There’s no place to hide with equities today — they all got beaten up. Financials are typically the first to recover but they caused this mess in the first place.
“Ultimately there are no guarantees. So stick with your plan. If you’re afraid of volatility, move slowly.”
Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors.