Back in September of 2008, we published an article called 8 Reasons to Stay Invested -
which highlighted the missed opportunities of market timing and the benefits of being
diversified in bear markets.
Now eight months later, the S&P/TSX Composite Index has returned over 7% year-to-date
in 2009 and there are signs that the North American economy could be improving. For the
week ending May 8, 2009, the S&P/TSX soared past the 10,000 mark for the first time in six
months, fuelled by slightly better-than-expected economic indicators and rising commodity
prices.
The debate now, is whether the markets are in the middle of a so-called W-shaped recovery
and facing another steep slide before any firm rebound, or if this is the start of an extended
rally that can provide investors with opportunities to add value to their portfolios.
Now is the perfect time to revisit and update our original 8 Reasons to Stay Invested article.
Here are eight tips that can allow investors to cautiously take advantage of market rebounds
and stay on track towards long term investment success, should the markets decline:
1. Market timing is rarely successful. Ask the most experienced investors, and most will
tell you that trying to time the ups and downs of the market is nearly impossible. The
S&P/TSX Composite Index has returned 36.2%1 since its lows in March. An investor who
got out of the market at that time would have missed out on the significant rebound.
2. Selling during a correction is betting against the odds. History suggests that periods
of sharp declines are often followed by periods of some of the most favourable returns.
The strong tendency of markets to rebound is evidence that market timing is not only
difficult, but in fact unnecessary for investors who simply stay the course.
3. Make sure you have some equity allocation in your portfolio. The likelihood of
negative long-term equity returns is very low. Stocks have almost always outperformed
bonds over any 20-year period. Just as compelling, a balanced portfolio of Canadian stocks
and bonds that is rebalanced on a quarterly basis has not produced a negative return over
any five-year period since 1980. The bottom line is that, although there are no guarantees
that the future will resemble the past, history has always shown that long-term equity
investors are virtually assured of earning positive returns, and of outperforming bonds.
4. Buying opportunities still surfacing. Positives in the market still surface for active
managers in bonds and equities and professional investors are taking advantage of the
unprecedented opportunities. For example, Prem Watsa of Fairfax financial turned more
bullish on equities towards the end of 2008 as his organizations was able to find
"opportunities across the world". History suggests that stocks are likely to outperform
bonds in the long run.
5. The global economic environment continues to have some positive signals. Many
headlines today are focusing on the global investment banking crisis and a global
recession. However, these negatives are being aggressively challenged by global stimulus,
both fiscal and monetary. These actions, along with lower oil prices and a generally low
inflation outlook, provides fundamental support to stock markets in the long run. We could
see favorable stock returns as the rest of the world has largely joined the US in supporting
market liquidity.
6. Short-term crisis often means long-term opportunity. While it's true that markets
sometimes get over-exuberant and prices become excessive, the opposite is also true.
Short-term periods of crisis can push prices artificially low, creating excellent opportunities
to buy at a discount. At Russell, we hire independent investment managers who can take
advantage of temporary market mis-pricings to realign our clients' portfolios. By doing so,
it's often possible to plant the seeds of tremendous long-term profits during periods of
uncertainty.
7. Market volatility provides an opportunity to rebalance. If a crisis creates an
opportunity, then portfolio rebalancing is perhaps the best way to take advantage of that
opportunity. Rebalancing means selling assets that have gained in value and buying assets
that have fallen in value in order to maintain the overall diversification strategy of a portfolio.
During a market correction, this results in buying more assets that have become discounted
- an essential part of the process of buying low and selling high. Systematic portfolio
rebalancing is a crucial aspect of Russell's portfolio approach. In essence, it provides
investors with increased exposure to opportunities that are likely to pay off in the long run.
8. Diversification is most effective when markets are uncertain. Investors who hold
well-diversified portfolios are able to participate in the growth of the markets with reduced
exposure to short-term market corrections. This protection against volatility is one of the
best reasons to have a diversified portfolio, and to rebalance the portfolio regularly.