It pays to stay invested

Business Times - 06 Jun 2009

WEALTH INSIGHTS

When market recovers, emotional investors will be left with a portfolio of defensive assets and a truckload of regret

By Lim Beng Tat, Director Russel Investments Asia

WE ALL know equity markets rise and fall. However, the recent market correction has worn down many investors. Weary of asking 'have we reached the bottom yet?', investors want to know when the recovery will come. And unfortunately no one knows the answer to that.

To sit back and watch investments post negative returns is simply unbearable for many. The truth is there may be more value in 'inaction' for the smart and disciplined long-term investor. And experience tells us that decisions about money made under highly emotional circumstances rarely turn out to be good ones.

What we do know is that when equity markets do finally have a rally (as history has shown they do) investors who have chosen not to stay invested in equity markets risk missing out on a recovery that could help them recoup some of their market losses.

Towards the end of 2007 we witnessed one of the greatest bull markets of all time. Investors in the Singapore stock market had been riding a euphoric wave of double-digit equity market returns over the preceding five-year period as can be seen in Chart 1. Then 2008 arrived and the party was over.

In the last few years many 'emotional investors' who traditionally invested in more defensive assets (such as bonds and cash) transferred money over to equities blindly attracted to the apparent returns without considering the associated risks. When equity markets collapsed, these emotional investors started to realise that markets could go down as well as up.

Similarly, over attention to risk during the current market downturn has focused investor attention on minimising losses rather than waiting to participate in the recovery. As a result, these investors have oversold equities and transferred the proceeds into bonds and cash.

Investors have also held back from investing in equity markets in recent months because there is continued uncertainty and a seemingly never-ending run of bad news of corporate failures and bailouts.

However, what many of these investors have forgotten is that when market do recover, they will be left with a portfolio of defensive assets and a truckload of regret.

Although the current market volatility - triggered by the US housing slump and sub-prime mortgage crisis - has been a painful experience, investors can take some comfort in putting the recent downturn into perspective. If we step back and look at the performance of the Singapore market over the past five or six years, it is easy to appreciate the value of long-term investing and it is quite clear there will be another 'party'. We just don't know when.

The current bear market's intensity has been compared to the Great Depression and the bear market of 1973-74. The 1973-74 bear market created many jumpy equity investors. However, those who maintained their equity positions were well rewarded in the second-half of 1974 and the first quarter of 1975.

Charts 1 and 3 illustrate this fact and also show the different time periods where US and Singapore equity markets recorded strong negative returns. As you can see, periods where there are heavy losses on the markets are generally always followed by significant bounce backs.
What we do know is that markets can't go down forever. Although sometimes, in the middle of a strong downturn, it is hard to believe that markets will one day recover. While nobody can accurately predict when the bottom of the trough will be reached - or if indeed it has already - everybody knows that it will (sooner or later) arrive.

And when it does, it will pay to be invested. Some of the highest returns are experienced suddenly in an oversold, overshot market.

Give it some thought - as shown in Chart 1, the Singapore market experienced consecutive negative returns in 1997 and 1998. However in 1988, the market bounced back in a big way climbing close to 80 per cent. We saw it again from 2000 to 2002 and then in 2003 we saw returns of over 30 per cent.

While it may be tempting to simply convert equities into cash and bonds and watch from the sidelines, history tells us that investors selling to cash during falling markets can expect to see significant underperformance when equity markets return to health.

Yes we would all like to 'buy low and sell high' but the reality is that emotions work against this investment principal. While extended bear markets inevitably induce fear in investors - professionals and individuals alike - a disciplined approach can help minimise losses during the downswing and ensure readiness for the upswing.

Forecasting represents predictions of market prices and/or volume patterns utilising varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.