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Thursday, 27 September 2012

WHAT SHOULD I DO DURING HIGH VOLATILITY IN THE MARKET?



What do you do when volatility hits the markets ? Questions like” do you think its time to get out of the market”, “do you think it’s the right time to invest more in the form of lump sums”, “do you think that the market is doomed ………etc.etc are frequent.

I thought it prudent to try and shed some light on:
1.       Why is the market so volatile?
2.      What should I as an investor do in a market like this?
3.      The value of cost averaging. Put differently, what is the value of investing on a monthly basis as appose to lump sum investments.

The JSE (Johannesburg Stock Exchange) has given an almost uninterrupted surge of gains from 2003 to September 2012. Considering so much growth then the 13% pull back of the market over the last few months should not be interpreted as a “crash”, but rather as market correction that will and should happen from time to time.

1.       Why is the market so volatile?
The major culprit contributing to the market volatility and correction started with  the crises in the US mortgage bond market. The “US Sub prime mortgage market”. What does this mean? Basically this was created by the banks in the US encouraging the public to borrow money on the increased value of their property. 

Resulting in the “Evil Cycle” that is, most of this money was used to spend on consumable goods hence the pressure on the US inflation and the resultant increase in interest rates. This resulted people defaulting on their bonds and the US property deflation. This “sub prime” problem has hit one of the British banks very hard where more than ₤3bil was withdrawn from the bank over a weekend placing the bank on the skids.

The saying goes, “when the US sneeze’s the rest of the world catches a cold”. The above has been a major contributor to our market volatility amongst other factors.

The fundamentals of the South African economy are still relatively very sound.

2.      What should I as an investor do in a market like this?

Simply put, stay on course! What do we mean by this? This is not the first time, and certainly not the last time that the market will go through a volatile period like this and this is the time where we get the real benefit of “cost averaging”.

Fancy term? not really. All it means, say we investing R1000/mnth into unit trust and paid R6/unit (ignoring cost) you would get 167 units. Should the market drop and the price of the unit is now R5, you would now get 200 units which mean that your average cost per unit has dropped which results in huge profits when the market goes up. 

So, if you’re a long term investor the longer the market moves down or side ways the better for you as it gives you the opportunity to accumulate more units at a cheaper price. When the market turns you smile all the way to the bank. However, should you panic and disinvest or make some drastic changes due to wrong or emotional advice you could end up losing, whereas patience and staying on course will give you the +300% growth. As I have said many times “it’s not how well we time the market but rather time in the market”


3. The value of cost averaging. Put differently, what is the value of investing on a monthly basis as oppose to lump sum investments.

The question that is often asked: “Why is it that I have been investing every month for the last few years but I have not seen the kind of profits that I have mentioned above? But my friend invested a lump sum in so & so fund and has seen big profits.”

Very important to note that firstly we should look at what is my financial strategy and what is my risk profile. Lets explain:

There are different types of risk profile unit trust funds i.e. High, Moderate and Conservative Risk funds. The growth rates decreases from high risk to conservative funds. Say you have been investing in a high risk fund and due to market volatility you felt you have made good profits and would rather move most of your money into a conservative fund. In the mean time your friend left his lump sum in the high risk fund. 

Two things to consider: 1. you have been buying in a market that has been climbing, which means that every month when you invest you are buying at a higher price which means you receives less units every month. Which results in a cumulative lower growth rate?

2. During the volatile market you moved your money into a conservative fund which will further reduce your growth as appose to your friend who has left his lumps sum in the higher risk fund. However, you must remember should you have left your money in the high risk fund and carry on buying in the decreasing or volatile market that with time and when the market turns your monthly investment growth WILL out perform your friend lump sum growth(as explained above). This has been proven. This is the power of cost averaging.    

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