How to invest in turbulent markets
By Alexander Chepakovich, CFA 2011-12-06Have you heard stories of people making fortunes in turbulent times by perfectly timing their purchases and sales? All of us had. These are great stories for mass media to produce – because they sell well. What we do not often hear, though, are other kinds of stories – stories of miserable failure of great many other market timers. I recon, that for every successful market timing incident there are four unsuccessful ones. The odds stacked approximately 4 to 1 against short-term investors.
Despite popular belief, there are no short-term investors who consistently beat the market. Arguably the most famous investor of all times Warren Buffett, for example, tries to minimize the market risk in all his investments. He never makes one-sided bets on short-term market movements. In fact, lately he does not make bets even on long-term market direction. He prefers to structure his equity deal in such a way that in essence they became debt deals.
So, what is the most sensible way to invest in the current situation, when there is no apparent end in sight to the sovereign debt crisis in Europe, political impotence in the USA, and slowing economy everywhere? Well, at the end there are only two possible outcomes for every market: it can either go up or it can go down (it can also stay unchanged, but, in fact, this is highly unlikely).
Assuming that all investors randomly make their choices, half of them will gain and half of them will loose. Those who gain will be hailed by media as superior investors compared to the ones that lost - even though, based on our assumption, all of them invested randomly. In real life, however, practically all investors make investment decisions based on their analysis and view on the market. Long-term investors with superior analytical and predicting abilities undoubtedly have an advantage. The key word here is 'long-term'. I argue that short-term investors or market timers as a group will invariably loose not matter what direction the market moves. This comes from our human nature: we tend to close a profitable position too early and keep a loosing one for too long with a hope that it will somehow return to profitability (no one wants to accept defeat and very few of us are ready to admit to making mistakes).
So, my answer to the question what to do in the current market environment is to stay calm and abide by sound investment principles that are applicable both in bad and good times. All of us know them, but well too often we don't heed them, relying instead on our "superior" understanding of the market. I would like to remind you of just two of these principles, which I consider the most important ones: 1) do not invest in risky assets more than you are ready to loose, and 2) always invest long-term (5 years minimum).