It is late March 2020, and the market has certainly been on a roller coaster ride, down by over 25% from the peak.
At RSM, our advisers have by virtue of our culture and investment philosophy cautiously positioned clients leading into the crisis, if for no other reason than markets had risen ahead of the fundamentals. The speed and ferocity of the correction has taken most by surprise, including us.
Where to from here?
I provide comments on the market by taking a step back and do solemnly swear not to mention the “c” word. It is near impossible to predict short term moves, so we will review some important rules to protect your financial future and thrive in the coming years.
Golden rule one
It’s good practice to have enough cash reserves, deposits, or bonds to cover between two to four years’ worth of your spending needs. This achieves two things, firstly it prevents you from having to sell shares at a loss to cover short term expenses. Secondly, it allows you to maintain a longer-term perspective by reducing anxiety around meeting your basic needs. Anxiety and emotion lead to poor decision making.
Golden rule two
Maintain and fix your time horizon. Shares should be bought with the view of holding for 5-6+ years. During times of stress, our time horizon shrinks. It is human nature. We don’t make long term plans when being chased by a woolly mammoth up a tree, or if we are worried about an incoming cyclone, we only think about what tomorrow will bring.
In contrast, when we feel safe and secure, we think a longer game and can have a four-five year outlook. We can invest in growth companies with the idea that dividends may follow as far as 5-10 years from now.
The opposite occurs during times of stress, we want cash and we want it now. If you follow rule 1 and have adequate cash set aside, rule 2 is about reminding yourself that your growth investments may or may not be sold for 5 or even 10 or 15 years from now. How relevant are today’s events in 5, 10 or 20 years?
Golden rule three
The value of one or a group of businesses is the sum of all future dividends and cashflows to be received by shareholders over decades. The value of businesses does not fluctuate as wildly as market prices, quoted by Mr Market.
If a formally profitable basket of listed companies earns no profits for the next two years due to a surprise shock, and then returns to healthy profitability, the impact of two years of lost earnings may justify a drop in the value the market of say 5-20%. This will depend on a few factors including the valuation pre-crisis, and the size of losses.
However, if interest rates move lower in response (making cash less attractive) and governments stimulate economies with programs worth trillions of dollars globally (further devaluing cash), it is very hard to argue that a diversified basket of stocks should be trading 35-40% below pre-crisis levels. It may be justified if new black swan arrives, but I would not bet heavily on two black swans in a row without having some money on a bet that in fact, the outlook may also dramatically improve.
If you own quality stocks in real proven businesses, (speculative holdings are another matter), and if Mr Market is quoting you a low price, a price that reflects a huge queue of desperate sellers trying to raise cash, just politely say “no thanks”. Mr Market late last year was offering high prices; Mr Market is moody, you can ignore him.
The long-term value of your shares is the sum of all future dividends, not what Mr Market quotes you today.
For more information
If you feel like selling in a panic, you have not followed the three golden rules above. If you feel you need to assess your cash levels/needs, your time horizon and goals keep fluctuating, or if you are unsure of the quality of your investments and their long-term earning power, please contact your nearest RSM Financial Adviser today to arrange a free phone consultation.