Should you TRUST the stock market?

14/01/2019
Posted in Blog
14/01/2019 Mduduzi Luthuli

What does it take to be a successful investor? Know some excellent rules, choose wisely among your many options, automate your contributions, and then wait (and wait some more) to get the results you desire. Simple right? Unfortunately, in real life, investing is tough for human beings who have fears, desires and other emotional reactions. This makes it difficult to “do the right things” with money we’ve set aside for the future.

Should you invest in stocks and risk losing the precious money you have set aside instead of spending it now on what you want and need? After all, anyone who’s even semi-literate about investing in equities knows that some losses are inevitable. So, what should you do?

Calm Down

As investment managers, we do see some growing concern among clients, but that’s par for the course in volatile markets.

Clients look to us for guidance, for surety in uncertain markets. Our biggest job now is to show them that we have already planned for volatility, keep them on track and keep them focused on the long-term. Our job now is to have faith in our investment strategy. The short-term market gyrations and all the conversations surrounding them are simply noise.

We say this confidently because history has taught us on several occasions that large market declines and periods of volatility have had a relatively short duration – 18 months on average – and have proven to be among the best times to invest.

The market should see a balance going forward of profit-minded sellers and opportunistic buyers. The increased volatility will occur because many investors expect to see the current bull market come to an end soon, and a sizable number of those folks will seek to lock in profits from their ‘high flyers’ by selling portions of those positions. However, that sales activity may also create some buying opportunities for other investors who are more optimistic, and thus increase demand for many of those stocks.

Trust

The decision to invest in the stock market requires not only an assessment of the risk– return trade-off given the existing data, but also an act of trust (faith) that the data in your possession is reliable and that the overall system is fair. The market offers no guarantees but rather is a market of probabilities.

Episodes like the collapse of Steinhoff may change not only the distribution of expected payoffs, but also the fundamental trust in the system that delivers those payoffs. You cannot be a stock market investor if you do not trust the fairness of the game (and the people playing it). This is a personal decision and one you must make yourself.

For many people, especially people unfamiliar with finance, the stock market is not intrinsically different from the going to the casino. They have no trust in the fairness of the game and in the reliability of the numbers to invest in it. If you are one of those people, do not invest in the stock market. How can you commit your money to something you have no trust in?

When the markets tank and take a chunk of your wealth, all that gets you through the day is trust; trust your investment manager knows what he’s doing or, if you pick your own investments, that your strategy will hold up. Yes, there will be more market corrections, recessions and economic downturns. Yes, people will lose money, especially if they act emotionally rather than rationally, but the market’s historical patterns of ups and downs provide perspective that should calm nerves. If you don’t believe in those historical patterns, what are you doing in the market? Speculating?

Questions to Ask

Will you need the money? – This is rule #1. If you will need to money in the next 5 years, don’t invest it in the stock market. Set that money aside in a safe and easily accessible account before you even think about investing in the stock market. If the stock market drops and you need the money, you’d be forced to sell at the worst time. On the other hand, if you can wait it out, your investment will most likely recover in 5 years. This is a particularly good strategy for index funds. Individual companies might not come back, but the whole market should do fine in the long run.

Will it impact your overall strategy? – You have an investment strategy, right? You need to figure out how much volatility you can handle. A lot of investors sell when the stock market drops and that’s exactly the wrong reaction. You need to buy more when stocks go on sale. Once you figure out your target asset allocation, you can use that as a guideline and stick with it through thick and thin. If buying more stocks will screw up your target asset allocation, then you probably shouldn’t do it.

Where did the money come from? – Where did you get this money to invest? Was it invested in the stock market before? If so, then it’s probably best to put it back in. For example, our dividend income is generated from the stock market. We’re not using it yet so it’s best to reinvest this income. This is particularly important for someone who received a lump sum from their pension. They will be very nervous about investing, but it was already invested before, so the money really should go back to being invested.

Final Thoughts

Whatever might happen to your money tomorrow, you’ll have to trust that your money will be okay in the long run, and if not okay, it might be better. You must start thinking in terms of decades rather than just months or even years. Investing is the longest game there is, and you must know how to play in order to stay in the game. There’s no need to be afraid of how things will end up tomorrow because you can look forward to the next couple of decades instead.

The worst thing that can happen in the stock market is that it can crash. But we’ve already established the fact first off that it will go back up again, inevitably. The only reason why the stock market sounds or feels scary is because you don’t know enough about it. Get educated and understand the terms, and you’ll soon realise that what you feared was just the things you didn’t know. If you knew the stock market like the back of your hand, you’ll know there’s absolutely nothing scary about it.

 

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