Monday, 29 September 2008

Riding the Investment Roller Coaster

If you are a stock market investor, lately the ride has felt distinctly like a roller coaster - gut-wrenching daily swings up and down, things going topsy turvy as major financial market players with long histories go bankrupt or get acquired in distress sales. It would be no surprise if you feel like the "I can't look" mother and terrified daughter on the real coaster in the photo.

In the last year, markets worldwide have suffered significant losses, as the chart below from Google shows (the blue line is the Toronto TSX Index, the red line is the US NASDAQ, the orange line the US S&P 500 Index and the green line the Exchange Traded Fund from iShares that tracks the EFA Index representing Europe, the Far East and Australasia).

What, therefore, should an investor do to make the ride less stressful, since unlike a roller coaster, which is just a trivial amusement, serious savings for retirement, a house or education are typically at stake?

Short-term Tactics
  • Protect against drops (hedge) with options - e.g. buy put options (see Put on Investopedia); like all insurance, there is a premium so this can get expensive
  • Protect against drops in stocks you own using various types of Stop Orders (see BMOIL's FAQ on Stops)
  • Do the "buy low" part of the old dictum Buy Low, Sell High - the survivors of the current financial debacle might well get stronger; the challenge is figuring out whether an individual company is a winner or a loser. Diligent homework and perhaps a bit of luck is required.
Long Term Strategies
  • Acknowledge the difference between short term swings and longer term market upward movement and stay in the game. The Google chart below shows the same market indicators since 2002, a mere six years ago - they are still significantly positive. Cast your mind forward six years, or better 10 or 25 years, and ask yourself whether the markets will be up. Nothing in life is guaranteed and markets could stay down a long time (Japan since 1990 being an example) and if you are convinced that is the case, pull your money and stay out. The worst thing to do is to try pulling out temporarily until better days arrive - many studies have shown that investors who try to time markets this way end up losing money compared to simple buy-and-hold (e.g. How to Handle a Market Gone Mad by Jason Zweig). The roller coaster always returns intact despite the scary ride. Trying to jump out of the coaster in motion is not advisable!

  • Adopt a portfolio suited to your psychology - if your ride creates real fear, maybe you should be on a tamer coaster, i.e. with less volatile investments. Maybe the girl should not have sat in front. Note in the photo how the lady in the second row seems to be calm and smiling to her child and the kids in the back are whooping it up! Partly, I believe this is a matter of getting used to it - having gone through the tech slide in 2001/02 this downturn is much less stressful for me.
  • Diversify your portfolio - as noted before in this blog in posts about portfolio design, having a number of stocks will dampen the swings and minimize the impact of disasters like the Lehman bankruptcy. Mixing in fixed income will further reduce variability and downward movements.
Ultimately, the stock market is not like a roller coaster - it does not return you to where you started out, it tends to end up higher.


Nancy said...

Hi there,

I'm considering becoming an online investor, but given the current state of the market I am hesitant. Should I wait for the markets to become more stable before going out on my own?

CanadianInvestor said...

Hi Nancy,
The current state of the market is indeed unusual, to all appearances in a state of panic rarely seen. That makes it a time of both great opportunity and great risk. If you cannot stand 8-10% swings in a day, which is about a normal change in a year, then you are best out of the market. If you have a long time to invest / won't need or want the invested funds for ten or more years, then this might be a good time to start buying. A BMO Nesbitt Burns report called Focus on Oct.3 ( took a look at various financial ratios and concluded at that time that stocks were at attractive levels compared to past recessionary declines. And in the past week there has been a further 15% or so decline! I do not know what will happen next - stability, further steep drop or recovery - nor does anyone really.

On the other hand, when stable and safe T-bills, CSBs and GICs are yielding less than inflation, you suffer a gradual loss of purchasing power.

If your question is whether you strike out on your own instead of sticking with an advisor, then I would say current market conditions make no difference. The same principles, advantages and disadvantages of DIY vs an advisor apply. NO ONE knows where the market is going short term and when ups and downs will occur. Even less so these days. In the long term the market goes up but the long term can easily be a decade or more.

Cheers and good luck!