If you haven’t been living under a rock, you would have heard of the on-going trade dispute between the two superpower countries – United States and China.
In fact, it’s getting worse by the day as China threatened retaliation if Washington goes ahead with their planned tariff hikes on additional Chinese imports on 1st September 2019.
We also have unprecedented events happening across the globe; like the Hong Kong protests, upcoming Brexit on 31 October 2019.
All while North Korea starts testing its missiles….again.
With all that in mind, many investors are wary of an incoming recession and thinking hard about this question: “Should I bail out of the stock markets now?”
The answer’s not quite so straightforward.
Hold and Sit Tight
Generally, when we say that we want to bail out of the stock markets now and get back in again during a market recovery, we are actually timing the market.
However, according to a Dalbar report, the consequences of trying to forecast the markets have led to some terrible results as per below:
If you look at the above chart, the average mutual fund investor has underperformed the markets for both stocks and bonds be it across 1 year, 10 years or even 30 years.
This tells a simple tale – the average investor is terrible at timing the market and should simply hold and sit tight even across recessions.
On the other hand, while the ‘buy-and-hold’ notion sounds good in theory, it is not that simple to execute when you factor in each individual’s investment profile.
This is because not every investor utilizes the same strategy or has the ‘stomach’ to sit through all the market turmoil and still sleep soundly if his savings over the lifetime has been cut by half.
Why? Your personal investment profile matters.
How Does Investment Profile Feature Into Whether You Should Sell or Not?
At the onset, every investor needs to be aware of his or her own unique investment profile which comprises of personal factors including:
- Investment Strategy
- Risk tolerance level
- Financial commitments
The above is a key exercise every investor should go through when it comes to investing. Knowing yourself well will help prepare you when things turn ugly in the financial markets.
1. Investment Strategy
If you have been investing for quite some time, you would have seen that there are plenty of investment strategies out there – Value Investing, Growth Investing, Dividends Play, Swing Trading, Trend Following and even Crypto trading.
Different kinds of investment strategies will turn out very differently when the markets turn sour.
For instance, value investors may jump into the markets to snap up bargains while Trend following traders may short the markets to benefit from the downturn.
Something I have noticed is the fact that many investors in Singapore have been adopting dividend investing due to the red-hot popularity about REITs; buoyed by the nation’s tax-free dividend gains.
As a matter of fact, many financial bloggers who touch on dividends investing have raving reviews on them. One of them who has managed to retire early at the age of 39 is none other than Christopher Ng. You can check out his investment philosophy here.
Thus, this group of dividend investors will have to pay attention to increased interest rates because it will cause the REIT’s interest expenses to balloon and distributions to fall if its also hit by an overall bad economy.
While we have always heard that it is better to invest for the long run, all of us have different financial commitments and temperaments.
In general, an investor needs to know how long he is invested for and what he is getting into it for.
- Are you investing for your retirement?
- Are you investing for a pot of gold in ten years?
- How long are you willing to wait?
These are questions worth answering before you decide to invest.
2. Risk Tolerance Level
A risk tolerance level measures how well you can stomach risks in times of adversity or simply put, it’s the “fear of losing money”.
Different people reach and manage risks in different ways. Some are ultra-conservative while others may be super aggressive. There are even some who are die-hard gamblers and look upon the stock market as a casino.
Only you know who you really are deep down.
It will be extremely difficult for someone who doesn’t know you well to recommend your course of actions when things start to unfold.
For example, imagine a particular stock falling 20% and one of your friends is saying that you should buy more to average down.
But you are getting butterflies in your stomach just looking at the 20% loss and thinking of whether you should cut loss instead. Meanwhile, a trader is short-selling the stock due to the share price crossing below some important technical indicator.
When we extrapolate the above example, we can get a general feel of how the supply/demand of the stock markets works, especially during market downturns.
As such, your risk tolerance level plays an important role here in determining whether you can sleep soundly at night when all the terrible news are broadcasting non-stop.
In addition, you have to understand that your risk profile is not static. It changes as you become older, wiser and start gaining investment experience. The first few years of investing is usually the most difficult period as your learning curve is steep.
For one, what is a 10% movement in the stock may have spooked you if you just got started investing; but it will probably not have such a strong impact to another experienced investor who has ‘seen much worse’.
We treat risk slightly differently. You can read how we felt after the stock price of something we invested in crashed, how we ultimately felt it was irrational, and how we decided to hold.
It was not the only time either. Risk, thus, is also determined by the depth of your knowledge.
I will give you an example.
The unknowledgeable investor who knows nothing of value investments and buys on the recommendations of his brokers, friends, hot tips, or even reading a blog (like this one) will not be able to say, “I shall hold since fundamentals have not deteriorated” upon seeing his investments tank like this, and like this.
In both cases, the fundamentals of the businesses encouraged us to not cut losses and run. And in both cases, since we knew fundamentals had not gone down the drain, we were able to hold our positions with conviction and eventually turn the profit.
Risk, thus, is also a measure of how much you know.
3. Financial Commitments
Investing is not done in a vacuum. We are all merely mortal beings with vastly different financial situations.
An old retiree of 70 years old who is no longer working is definitely more risk-averse as compared to a 28-year old who can continue to draw a salary for the next 30 years.
The retiree has a lot more to lose given his huge asset base.
He will likely be unable to recover from the huge blow to his portfolio with his life expectancy at stake.
Imagine he has amassed a huge sum of $1 million dollars and the recession drags down his portfolio by 50%. His portfolio size is now valued at $500,000, and he can only live out his retirement based on the new amount now.
On the other hand, many investors around my age are also preparing for their big financial commitments – getting married, buying and renovating a house and purchasing a car to prepare for a newborn. These will really hamper your financial judgement if you get hammered by the downturn and have to fork out capital for all these big-ticket items.
In conclusion, the notion of investing for the long run and avoidance of predicting the upcoming recession is well supported by many research studies.
However, things aren’t that straightforward when we factor in our different investment temperaments and financial commitments. This brings us to the second-best option one can possibly adopt – portfolio rebalancing.
An important element of successful portfolio management is periodic rebalancing and a generally good idea is to do it annually to re-assess your portfolio allocation.
In addition, it should be structured with your specific risk tolerance and financial situation in mind. These are not things, or terms, or conditions others can do for you.
You have to be the one to sit down and really probe your own mental resilience in order to figure out how you should allocate your assets.
To end off, the decision whether to bail out of the stock markets is mostly a personal one because ultimately, you are the only one who will feel comfortable about your investment decision.
Personally, I value the ability to sleep through the market turmoil more than going against my own comfort zone trying to get things right.