Stability in an unstable worldBy Randell Tiongson on June 13th, 2012
Question: How do you invest wisely in an unstable market? What are the criteria that one should look for?—Rigel Kent Tugade (@rigeltugade) via Twitter
Answer: What you asked me is one loaded question. There are many ways to answer that question so let me take a shot at it. There really is no such thing as a stable market, in my opinion. Markets go through cycles or seasons. There are many things that affect market movements but largely, they are responding to the law of demand and supply. What investors should be wary about are wild fluctuations in the market environment and, unfortunately, that is what we are experiencing now.
Market movements, to a great degree, are about perceptions and fundamentals. People have a tendency to be severely optimistic or extremely pessimistic with their reactions which the markets reflect. Fundamentals of companies, business, economy and even politics affect markets in general. If business environment is good, companies are profitable, the economy is growing and there is political stability, expect the markets to respond positively and vice versa.
Severe movements in the market have both positive and negative impact. On a positive note, opportunities can be found with volatility for those who are risk takers. The downside of course is that capital loss can easily be experienced just as fast as profit can be made. The relationship of risk and return always comes into play whenever you invest. Yields will always be a function of the risk you are willing to take and as the cliché goes: High risk, high returns and low risk, low returns.
When investing, it is always prudent to know your investment objective, time frame and risk tolerance first and foremost. Investment instruments should be able to match the three I mentioned before considering parting with your hard-earned money. If your objective is long-term in nature, like retirement or college funding for your young children, then you may consider long-term instruments even if they can be volatile, like stocks, mutual funds and UITFs [Unit Investment Trust Funds], or even real estate. Although they are volatile, they are expected to grow over time—well, at least in theory. You may also want to practice cost averaging when you are investing in those instruments. You can invest regular amounts periodically, thereby averaging your investment cost. When market is low, your investment will allow you to buy more shares and vice versa—you will realize that you have gained from your investment over a long period of time. Cost averaging only works if you have a long-term perspective, say more than five years. I usually recommend monthly or quarterly investments over a long period of time because it is practical and it allows you to fully realize the benefits of cost averaging.
However, the best advice I can give you is to practice “diversification.” No one can predict what will happen in the future. While technical and fundamental analysis helps one discern, there really is no way we can be certain as to what will happen. It is best to diversify your portfolio among low- and high-risk instruments, as well as high liquid and low liquid investments. Having a severely low-risk portfolio means your money is not growing efficiently and is most likely growing at a rate slower than inflation. Over time, the value of your money diminishes as it loses purchasing power.
A very high-risk portfolio, however, can cause you many sleepless nights as fluctuations in the market can severely deplete your capital. As a financial planner, my recommendation has always been to strike a healthy balance and avoid extremes.
The good book even recommended diversification and here’s the proof: “But divide your investments among many places, for you do not know what risks might lie ahead.” (Ecclesiastes 11:2, NLT)
I hope this answers your question. By the way, the best thing you can do is also to invest in financial education.
* Appeared at the Philippine Daily Inquirer