ON March 23, 2020, global markets rapidly plunged to their lowest levels year to date, following days and weeks of wild swings driven by tremendous investor uncertainty. This year’s crisis is unprecedented, in that it is different from any other which most of us have experienced in our lifetimes, burgeoned from a global pandemic caused by the novel coronavirus and the uncertainties that surrounded its impact on economies. If you are a seasoned investor, the past few months must have been quite a roller-coaster. If you are not a seasoned investor, you may have some trepidation to enter the market. Notwithstanding the uncertainties, the crisis has given rise to opportunities which could be successfully availed as long as your investing decisions are guided by basic but cardinal rules.
Rule 1: Know your investment objectives
What is your investment horizon? Short, medium or long term?
What is your risk tolerance? Risk-seeking or risk-averse?
At the onset of establishing your portfolio, these are some of the questions you must answer honestly in order to determine your investment strategy, specifically: where, what and how much you want to invest.
Making changes to your investment portfolio is dependent on your investment objectives. If you are investing for the long term, this investment horizon should be top of your mind; it will prevent you from panic selling and realising losses unnecessarily. Instead, you can pick up new positions while continuing to build a diversified portfolio or average down your cost of existing investments.
If you are a risk-averse investor or one who is investing for the short term, you may want to minimise your risk by early liquidation of those positions that are susceptible to continued volatility and instead, hold cash until the market turbulence subsides. It is important to mention that such investors should have little to no exposure to equity markets.
Rule 2: Diversify your portfolio
Holding a well-diversified portfolio is a strategy that has stood the test of time.
Building a portfolio with a mix of stocks, bonds and other asset classes helps to diversify your overall risk. Choosing investments that are not positively correlated helps to smooth out performance when there is turbulence. In other words, choose investments which react differently to the same market conditions.
Figures 1 and 2 show the five-year movement in two major market indices; the Bloomberg Barclays US Aggregate Total Return Index (measures the performance of the investment grade US dollar bonds) and the S&P 500 (measures the performance of large cap stocks on the New York Stock Exchange) respectively.
From the short-term view, the year to date (January 1 to March 31, 2020) return excluding dividends, on the US Aggregate Bond Index was +3.15 per cent, whilst the return on the S&P 500 Index was -20.00 per cent. An investor holding equal exposure to both indices would have yielded a return of -8.43 per cent for the same period, faring better than an investor who was solely exposed to the S&P 500 Index.
From the medium to long term view, both graphs show that the pull back in March 2020 was not at record lows for the long-term investor. In fact, assuming you held equal exposure to both indices in January 2015 and continued to hold on to your position, your returns for the period, not inclusive of dividends would be 22.69 per cent (comprising 19.85 per cent for the Bond Index and 25.53 per cent for the S&P 500 Index)
It should also be noted that as at mid-June 2020, both indices have significantly recovered from their March 2020 lows.
Rule 3: Information is critical
Whatever you choose to do; buy, sell or hold - your investment decisions should be supported by information.
Information will never be perfect since no one can predict the future, however, understanding the economic environment and the fundamentals of a company and the industry in which it operates will help you to make better investment decisions.
No matter the type of investment, best practice is to buy low and sell high. This requires an investor to make disciplined decisions based on their investment objectives and pertinent information.
Rule 4: Seek advice from an investment professional
The financial markets can be daunting for most, but we have experts who can guide you through this process. Remember these basic rules identified in this article and do not invest in instruments you do not understand.