My editors want me to at least occasionally write about something topical. At first glance, a column about getting back into the market doesn’t appear to fit the bill, but it does. That’s because now is the time to do the groundwork for what is often the most difficult decision in investing.
There are a large number of investors (the most I’ve seen in 30 years) who’ve been frozen by the possibility of another 2008 and don’t own any stocks, or at least are well below their long-term target. Unfortunately, they’ve missed out on some good returns. Since the end of 2008, Canada’s S&P/TSX composite index has had a cumulative return (including dividends) of 53 per cent, while the MSCI World Index was up 29 per cent (in Canadian dollars).
To be clear, I’m not expecting the under-invested to load up on stocks at this still volatile, debt-burdened time, but I am hoping they’ll start to plan for that eventuality. I say “plan” because the decision to buy stocks again won’t be easy. It wasn’t easy over the last three years and almost no set of circumstances will make it any better over the next three. Even if there is a big market drop, which would be the perfect scenario for the under-invested, there’s no guarantee of action. A bear market will confirm all the negatives, and make buying just as difficult.
A plan is also necessary because it’s not ordained that the stock market will ever drop back to a hoped-for level. It might, but the power of compounding is undeniable and markets do rise over time, leaving previous levels behind forever. Investors waiting for the TSX to retreat to 2,000 in 1983 never saw it, nor did those who set their buy target at 4,000 in 1995.
If you’re in this situation and want to plot a re-entry strategy, there are some basics you have to come to grips with. You have to believe that your biggest risk is losing ground to inflation (not volatility and market dips); that stocks will provide higher long-term returns than fixed income; and that a bumpy 5 to 6 per cent return is preferable to a smooth 2 to 3 per cent.
If you’re good with that, there are a few things to think about as you prepare to buy stocks.
First, you need to refresh your investment plan and confirm what proportion of your portfolio should be invested in stocks.
Second, you need to immediately stop reading the doomsday scenarios (they’re possible, but you already know them) and start monitoring asset prices. With few exceptions, investors who stayed out of stocks did so because of big picture concerns. Little or no consideration was given to the valuations being placed on companies. But you need to give valuation at least equal time, even if economists and the media don’t. It is the most reliable predictor of long-term returns.
Remember that tech stocks didn’t plummet in 2001 because the Internet failed to live up to its promise. They went down because valuations were in the stratosphere. And the current run that started in early 2009 wasn’t fuelled by a rosy economic outlook, but rather by too many stocks getting ridiculously cheap.
Third, you need to stop pursuing perfection. It’s not something you try to achieve at other times in the investing cycle, and you shouldn’t strive for it now. You’ll never get invested if your goal is to make up all the lost ground with one brilliantly timed purchase.
I’d suggest you buy in stages and pursue a goal of being “approximately right.” If you currently hold 20 per cent in stocks and your strategic asset mix calls for 60 per cent, then you might consider narrowing the gap with four purchases of 10 per cent each (i.e., going from 20 per cent to 30 per cent, then 30 per cent to 40 per cent, and so on) over the next six to 18 months. This approach will mean that your purchases are either too early or too late (i.e. before or after the market low), with some being better than others. Not perfect, but practical.
Being out of stocks during a rising market is a tough spot. It’s a huge bet against your long-term plan and there’s no perfect solution. If you’re in this situation, I strongly urge you to set a plan for re-entry and then take some baby steps towards getting back on track.
Tom Bradley is president of Steadyhand Investment Funds. He can be reached at firstname.lastname@example.org