Most times in life, when we are looking to buy something, we view falling prices as a positive factor. If we want to buy a new television set or furniture, we often wait for the sales to get better value for money. Lower prices can encourage us to buy. If the prices of cars made by your favourite manufacturer have fallen, you may take the opportunity to buy a new car now.
The scenario is similar with property. Even though when we buy property we hope it will rise in value over the period we own it, many people will take advantage of falling property prices to make their purchase.
When it comes to equities, however, people behave very differently. Falling prices make them fearful and they refrain from buying shares at that time – they may even sell the ones they have. Inversely, they see rising prices as a good thing and buy shares when prices are high.
John Templeton quoted American investment specialist Benjamin Graham when he said: “Buy when most people... including experts... are pessimistic, and sell when they are actively optimistic.” Easier said than done though.
Emotions play a large part in investor behaviour. As the price of an asset rises, investors are attracted by the returns they have seen so far and buy this asset. They do not mind paying more than they would have done a few weeks before because they still expect to make a profit. However, if you have ever seen the ‘cycle of market emotions’ graphic, the point of euphoria when prices are highest is also the point of maximum investment risk because that is when it is most likely that prices will start to come down. So many investors find they have bought when prices were at their highest.
Likewise, as markets fall, investors get fearful about losing their money. Many investors sell their shares, causing further falls. People with money to invest sit on the sidelines, waiting until they feel confident that prices are back on an upward path. However, when markets are lowest, the point of despondency is also the point of maximum financial opportunity.
Buy when most people are pessimistic, and sell when they are actively optimistic
Although stock market volatility can be uncomfortable, it can bring value back to the markets and create opportunities. If you have capital to invest, share prices falling can be a good time to buy. You can potentially buy more shares with your money, shares that will rise in price once the downturn ends.
If you are still concerned the markets may fall further, you could apply the principle of ‘pound cost averaging’ (or euro or dollar cost averaging, depending on your base currency), which would result in an investment being allocated gradually and strategically over time.
The principle of pound cost averaging notes is that if you invest, say, a third of your money on one date, a third two months later and the remaining third two months after that, the average of your investment will provide peace of mind – since you haven’t invested all the money at once, you are not unduly exposed to the risk of the market falling the day afterwards and a better opportunity having arisen.
Only one of the three dates will have provided the best prices returns, but it means you can be ‘in’ the market from day one in case the market rises from then.
As history has shown us, markets always recover eventually. If you look at the last five decades, declines have been followed by upturns which on average have been longer lasting and with gains larger than the losses preceding them.
What we cannot know in a downturn is when markets will hit the bottom. If you keep waiting for this to happen, you will probably miss the upswing, which is often when price increases are sharpest. Do not risk waiting too long.
Make your investment but be prepared for further short-term volatility and, importantly, you should be prepared to hold your investment for the medium to longer term.
Remember, there is nothing wrong in taking risk, providing it is managed and you do understand the type of investments undertaken. Unless you are a savvy investor and you do understand the market, it is always advisable to seek professional advice from a regulated investment adviser.
To keep in touch with the latest developments in the offshore world, check out www.blevinsfranks.com.
Jean Chapelle is senior manager, Financial Planning and Business Development, Blevins Franks.