Markets tumble more than 30%. Don’t panic – Try this instead

Temperament is everything

Investors can often get in their own way. It can be hard to stomach a bear market. But it’s especially important at challenging times like these to keep our emotions in check, or else we could make mistakes and lose our shirts.

There are three types of investors during a stock market crash – those who sell, those who do nothing, and those who buy more. Which type are you? If you don’t already know then this can be an expensive time to find out. We learn the most about our investment behaviors when the market is tanking, not when it’s rising.

The global influenza pandemics of the 1950s and 1960s killed more than 1 million people each time. But eventually the world moved on and financial markets recovered. It’s a bit counterintuitive, but profits are made when you buy, not when you sell. This is because the price you pay for an investment is the main factor that will determine your future profit.

How to buy into the dip

If panic selling is not a good idea, then what can we do? Here are a few common strategies to consider:

• Rebalance approach
  Although most securities are down, government bonds and other fixed income funds like (VSB.TO) have gained. Sell some of these low risk assets to buy beaten down stocks. But do it gradually. This also helps to rebalance your portfolio to your previous asset allocation.
• Gradual nibble approach
  This requires you to have some cash saved up first. Every time the market falls by 10%, you put more money into the markets. Start with 20% of your cash balance. Go up to 30% of your remaining balance the next time. Then 40%, etc. This ensures that each additional time you buy, you are picking up stocks at lower prices.
• Wait for a bottom approach
  Sit on the sidelines and wait for a sustained rally using technical analysis. Save and accumulate cash in the meantime. Store this cash in a high interest savings account or short term bond fund so it can be liquidated relatively quickly. Once market momentum starts going up again use 75% of the cash to buy stocks on the rise. Gradually buy more with the remaining 25% over time.

I don’t know which method works the best. But here’s what I’m doing:

As posted in my latest net worth update, I had about $150,000 in cash at the beginning of March – a very fortunate position to be in. 🙂 I’ve already spent about $80,000 of that buying into this bear market over the last few weeks. My most recent stock purchases were Suncor (SU.TO), Pembina Pipeline (PPL.TO), Canadian National Railway (CNR.TO), and Fortis Inc (FTS.TO). I’m buying even as prices continue to fall because the stock market is down 32% from its high so far. Historically 32% is the low point of the average bear market. Although stocks could fall further, investing about half of my cash savings now guarantees I don’t miss out on the upswing in case we are already close to the bottom.

I plan to deploy another $50,000 into the market after technical indicators improve. There are two primary signals I’m interested in.

• I’m waiting for the 10 day moving average to reverse direction from down to up.
• I’m looking for the MACD signal to improve.

These indicators can be applied to individual stocks, sectors, or entire indices. For example, below is the S&P/TSX index. We can see it is not yet time to buy.

A new bull market should start once we see price momentum swing up. 🙂 But this is speculation. Even after a short term bounce, there could be more downside before things actually start to turn around.

Beating the market with time arbitrage

Long term investors should view market pullbacks as opportunities, not setbacks. At any given moment the stock market only thinks 3 to 18 months ahead. However, individual investors can think much further ahead which gives us a tremendous advantage. 🙂 We can use the inefficient, short term market swings to buy high quality companies when they become oversold. Playing the long game is easier than competing with traders and analysts over short term outcomes.

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” ~Benjamin Graham

A stock’s “target price” refers to what analysts believe each share will be worth a year from now. Here’s an example for BCE, a major telecom business.

But analysts never provide five or ten year price targets. Ironically it’s easier to predict long term stock prices than short term. For example: I have no idea what BCE shares will trade at next week. But I’m pretty confident it will be a lot higher in seven years from now. Everyone needs a phone. Even Mr. Potato Head has a mobile device – incase Mr. Onion Rings. 😀

“If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people… Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue” ~Jeff Bezos

Having a long term investment horizon is the best advantage you and I have against Wall St.

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Random Useless Fact:

Introverts are usually better prepared for pandemics than extroverts.