Does the current crisis pose the opportunity of a lifetime?
Lately I’ve noticed a change in attitude. It just might be my wishful thinking, and I certainly don’t have any objective data to support this feeling but I think something is shifting.
No one can really answer this question but I certainly feel the tide changing. If you remember previous discussion I’ve always thought that reduced volatility in trading will be one of the predicators to the first steps out of this crisis. We’re not there yet.
The good news is the stock market is a lot more like a speeding bus and a lot less like a light bulb. It’s not an on/off, 1 or 0 thing. If you see the bus begin to speed away you can still catch it. Losing the first 10% (or more likely 30%) of price shifts is a relatively small price to pay for more quiet and peace of mind.
The problem: Most of us don’t have the privilege or investing the Warren Buffet way
Attempting to be fearful when others are greedy is relatively easy. Being greedy when others are fearful is the tricky part.
I believe any investment made today will very probably generate generous returns in 5 years time. The problem is I don’t have enough money to commit myself for such an investment term.
Furthermore, and much more frustrating, had I had $100,000 more I still wouldn’t feel secure enough to risk more than 30% of that sum. Being greedy when others are fearful is a privilege for individuals and companies with very deep pockets.
It kind of reminds me of that statistical “trick” played in casinos, for examples, where you simply double your previous bet to earn the initial sum you’d bet on. For example, you bet $1, lose it, then bet $2, lose those and then bet $4 to win another $4. You net gain is $1. The problem is that this geometric column advances in a scary pace (2 in the power of …). Try to deploy this strategy and you’ll find yourself betting $256 in 8 turns or $1,024 in ten.
What can we hope for as household investors?
Household investors should stick to basic principles when it comes to stock investments (I guess you’ve read these before so I’ll try and emphasize the more important aspects. If you’d like to explore more please browse my investing section or top posts):
#1 Stock investing is a long term commitment
Even though prices seem relatively inviting the market can quickly turn around again. For long term investors the economic environment is relatively enticing. Prices have reached a level which prices the risk far better than a year ago; some might say pricing too much risk.
Keep in mind you’ll probably face more crisis along the way. The clean-tech bubble, the Chinese bubble, or what not (who knows). It takes quite a stomach to being a long term investor.
#2 Dollar cost averaging can really help off-set some of the risk
Although academic researchers and finance professors disagree on this somewhat it seems spreading your investments over a certain period helps off set the risks associated while also lowering potential return (this should be clear).
I’ve written a more detailed post on dollar cost averaging which shows how it helped even out returns for investors in the US and Japan (where the market has been performing poorly for 20 years).
The market environment is currently very interesting for those who seek to start investing slowly, a certain amount each time. Prices are relatively low and should they drop more you’ve got yourself a better price for you next investment.
#3 Diversification and asset allocation
As mentioned diversification can’t help much when it comes to a crisis such as this. Still it’s far better to lose the average market loss than lose 90% in any given stock. Diversification, together with asset allocation helps in building a more robust portfolio to better withstand shocks.
Avoiding risk altogether is not an option
Extreme risk aversion is not the answer. In Extreme Risk Aversion Paradoxically Leads to Another Huge Risk I discussed why avoiding stock investments altogether creates another significant risk, that of failing to meet our financial goals, especially our retirement goal.
Stock investments are the only tool which can really provide the added value much needed in long-term savings. A 2% difference in the average yearly return is most significant and practically dictates a whole other lifestyle in retirement.
I promised to keep you updated when I make my move back in the market. I’m usually a terrible proxy and would advise you to sell the moment I buy but it’ll make for an interesting, and more importantly long term experiment.Diversification, growth investments, investment, massive losses, opportunity of a lifetime, problem, relative sanity, risk, systematic risk, way