As I write the world’s major stock markets continue to suffer substantial turbulence and heavy selling with many into technical “bear territory” – This is where a group of shares have fallen in excess of 20% from their recent highs. As an example, the main UK market is down about 20%, Germany by 22%, whilst Greece & China are down over 40%. Understandably this can cause people to question their investments and, in many instances, panic sell.
Shares are not the only investment to have fallen, with other areas including oil and the wider commodity market suffering, so what is the best option?
What to do when markets collapse
There is normally very little to gain from making any rash decisions. Also, it is unlikely that you will be uninvested unless you really have no financial wealth. To clarify, selling shares doesn’t make you uninvested it simply changes what you have invested into
. There are a total of 7 main investment classes so your wealth will be re-invested elsewhere with the options being: cash, bonds
, property, commodities
, hedge funds
In this respect any tendency to panic sell should also reduced by allowing you to focus on the reasons for transferring your wealth. For example, selling shares and keeping the sale proceeds in cash should be considered as purchasing cash instead of selling shares. There are many sound reasons for buying cash including having the ability to benefit from future low investment prices, bolstering any emergency cash reserves and to make non-financial short term purchases. You should, however, be buying it for the right reasons and not as a default option.
By confirming when and how much you require for your goals it may affect what your reaction will be. For example, someone saving regularly for retirement in 30 years will likely be unaffected whilst another person saving for a home deposit in a year’s time will probably have a polar opposite reaction.
Ideally being on top of your finances can allow you to better cope with market collapses when they happen. As sure as night follows day another financial crash will occur. The extent may even be far worse than that of 2008/2009 and may exceed the great depression (beginning in 1929).
Financial markets are full of vested interests and artificial meddling. Unfortunately in the modern environment there is no way of getting away from it. This makes it very difficult to time markets, thereby buying and selling, at the right time. Since all markets are affected (cash produces little interest and has done for years, numerous different government policies have been very accommodating for bonds and properties whilst increasing share prices has been a specific goal at certain points). This makes trying to establish what happens next tricky though that does not mean nothing can be done.
Risk of investments continually change depending on circumstances
, including the time horizon for an investment and current market conditions. It is important to establish what level of risk you really are taking rather than assuming general norms will apply. For example, cash, although good for emergencies and short term goals, struggles to perform in the long term. Bonds which can be classed as low risk may be anything but if the environment changes causing interest rates & inflation to increase. Property could become a victim of political policies which may increase the tax burden or other costs. Shares, which have been seemingly underwritten by governments may face turbulent times. Establishing how risky certain investments are can minimise any nasty surprises in the future.
Just because one market experiences large falls this does not necessarily lead to contagion in other investment classes. In fact, certain choice investments can thrive whilst others decline rapidly.
Having a diversified investment portfolio, all else being equal, will reduce the level of risk that you are taking. Be aware of how correlated your investments are. For example, if you split your investment portfolio between stocks and bonds but they are all ultimately linked to one country it is still a fairly risky proposition. By diversifying across multiple fields including differing geography, asset classes, currencies, and cultures this should reduce your risk a lot more.
Risk is a combination of time and volatility therefore the more time you have the greater the level of price changes you can take. On the whole, the more volatility you endure the higher your expected returns should be.
It is very difficult to judge what will be next for markets. Will they continue to fall like a stone, recover, or remain flat from here? Although I mentioned above that timing the markets is tricky it doesn’t mean that we should ever shirk from making a decision. Far from it, instead we should make a call and revise it if need be thereafter. For my tuppence worth I expect markets to recover at least in the short term. The reasoning being is that we are in a low to negative inflation environment. Governments have the means to bolster this which has happened many times since the original stock market crash of 2008/09. Any time a major market fall has happened governments via their central banks have made money more freely available and at lower rates which has seeped into all manner of investment types pushing prices up despite the real economy gaining little benefit.
Trying to fight governments actions could have been very costly. If you invested all your money in cash when markets fell to their 2009 lows expecting them to reach a clearing out point from which companies could realistically be expected to recover then you would have lost out substantially in the previous years. Since 2009 there have been numerous scares for asset prices and each time central banks have stepped in leading to new highs and deflation being contained. This is another reason why my gut feeling is to invest for the foreseeable future.
What is of concern is what may happen next. That is when inflation starts to take hold whilst everyone continues to concern themselves with deflation. This is a major threat because it will be far harder to contain without causing havoc. It may cause a lot of lost wealth to those in previously considered low risk investments of bonds and property. The latter should not be a concern unless it is an investment or if you have overextended. The former are priced near perfection for continual low rates and, in the main, should be avoided. Governments will be walking a very thin line between not raising rates fast enough leading to rates being higher in the end and lifting interest rates too sharply which can have a negative impact on the country’s growth.
To sum up, keeping a well diversified portfolio with an underweighting of bonds whist awaiting the next stage, inflation, is my advice for a general course of action at this point in time. No panicking and no mass selling.