I admit we are going through scary times, but having been an investor for many years I am not unduly worried.
Investors have suffered a hair-raising couple of weeks, with some markets plunging as much as 9% in a day, only to recover strongly the next. And, of course, the question on everybody's mind is whether to buy, or get out now, and buy back in when the market has recovered.
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Times like these are nothing new, but I have found the best way to handle them is to fall back on the basic investment principles that have stood me in good stead for more than 50 years.
The first one is that nobody can consistently and accurately forecast what markets will do.
"The wisest man knoweth not when," says the proverb, and so it is with shares. In fact, I have never known a single day when, on the day, it was the right time to go into the market. If the market is booming you are scared of getting in at the top; if it's depressed, you are scared that you'll be investing into a downward trend.
Because I accept the fact that I don't know when tops or bottoms will occur, I tend to stay fully invested, with the proviso that I always have enough cash in the bank to supply our spending needs for the next three years, when added to our expected dividends. Sticking to this principle has been a real pain in the last week, because I have been salivating at the thought of buying at some of the low prices that have been on offer.
But I have stayed true to my principles and bought nothing. The last thing I want to do is put myself in a position where I buy shares that look cheap now, and am later forced to sell them at a loss because I've used up my precious cash reserves.
The next principle is that the price of a share does not necessarily reflect the value of the company. The behaviour of markets has been especially irrational this week. Just because the price of oil fell 30% (because of a spat between Russia and Saudi Arabia) some of our biggest blue-chip companies had falls of more than 8%, yet their balance sheets are still in good shape, and they should remain good long-term businesses. Investors can act in strange ways: they love to buy when the market is booming and shares are fully priced, but shy away when prices fall and the same shares are at sale prices.
Cashing out now in expectation of buying back is a very high risk strategy. Capital gains tax may take a hefty proportion of your sales proceeds if you do decide to sell, and it's highly likely that the next bounce will catch you by surprise and leave you chasing a market that is rising again. A much better strategy is to accept that volatility is the price you pay for the flexibility and high potential of share-based investments, and simply hang in there and wait for the recovery.
I admit we are going through scary times, but having been an investor for many years I am not unduly worried. I lived through the 1974 credit squeeze, when loan finance dried up overnight, lost sleep in 1987, endured "the recession we had to have" in the early 1990s, and have vivid memories of walking around the City of London in 2008 when Lehman Brothers went belly-up.
It's impossible to say exactly when the current market turbulence will stop. However, we can be confident that the share market will eventually recover - as it always has. Good quality companies with real businesses, and sustainable earnings and dividends, will once again be sought by investors, and so they should recover well.
- Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. noel@noelwhittaker.com.au
