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Money: What should we be doing about the next market crash?

27 Sep 2018

Lately, it has been impossible to avoid media articles about how the next market crash is over-due. Share and property markets have been going up steadily now for at least six years and several media pundits have suggested that the good times can’t go on forever.

This has encouraged our clients to ask questions like, “What are you doing to protect me from the next market crash?”

The short answer to this is “Nothing that we aren’t doing already; it is business as usual.”

It is a very human desire to try and predict the future, or the next market crash. Of course, we understand that. If we could do it, the rewards would be marvellous. We would be invested in shares and property only when they are going up and revert to cash when shares and property are going down. We would very quickly become multi-squillionaires.

But of course, we can’t do that.

We often see economic forecasters predicting the next crash only to find that they have predicted 15 of the last 3 crashes. If they keep on predicting a crash, they will eventually get it right.

There have been countless examples over the years of investors and their advisers selling up all their growth investments and sitting in cash, or gold, for the foreseeable future. That raises the problem, if they do get it right and are out of the markets when a crash comes, of when to go back in again. You must get two decisions right to win, getting out and getting back in again at the right time.

I know of people who have missed the last three years of gains from shares and property while they have been sitting on the side-lines. They have missed up to 33% growth or 10% per annum compound, after tax and all costs over that time from a typical diversified portfolio, depending upon the mix.

Right from the start, investment portfolios are designed to withstand ups and downs in value. Not perfectly, but nevertheless, helpfully. How do they do this?

  1. Bonds and cash are added to the mix alongside shares and property. We call these sectors ‘defensive’. Bonds are just like term deposits that are traded every day and they go up and down in value a lot less than shares and property. As well, they typically go up in value just when you need them – when there is a share market crash. Our government bond fund went up 20% for the year in 2008 at a time when shares fell 25%.
  2. Bonds are a natural balancing act for shares. It doesn’t always work, but they help to reduce the ups and downs in value overall.
  3. Investors who are more vulnerable to a share market crash have a higher percentage of bonds than investors who can weather the storms more easily. Our clients range from 60% bonds all the way down to 0% bonds depending upon their situation.
  4. During good markets and bad, we rebalance the portfolio a couple of times a year, more often, if required. After a crash when shares have gone down and bonds have gone up in value, by rebalancing back to the agreed original mix, we end up selling bonds and using the money to buy shares and property. Effectively using the opportunity of a ‘fire sale’ to stock up on cheap goods. Just like we do when baked beans are reduced heavily in the supermarket, we buy six cans instead of two. Notice in that example above, we ended up selling the expensive stuff, the bonds, and using the money to buy cheap stuff. Rebalancing is the sensible person’s version of the elusive job of predicting the next crash.
  5. Emergency funds. People who rely on their investments to produce a regular supply of cash to fund their lifestyle, should hold emergency funds in term deposits outside their investments. Anything from three months’ supply of spending money up to a year’s needs can be kept apart from the main investments. Then, in a market crash, while their investments have dived in value, they can turn off the regular distribution they have been taking for spending and use their emergency funds instead. In this way their portfolio can recover, re-investing the income that is being earned within it for at least a year before having to turn on the distributions again. Again, this cash from dividends and interest within the portfolio is being used to buy up the cheap shares while they are on fire sale.

There is the old saying, “It is time in the market rather than timing the market” and this is the gist of what we are saying here.

You wouldn’t pull up a strawberry plant to check the roots to see why it isn’t growing. You must be patient if you want to eat strawberries for Christmas.

Keep asking great questions …

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