Temperament is everything
Investors can often get in their own way. It can be hard to stomach a bear market. But it’s especially important at challenging times like these to keep our emotions in check, or else we could make mistakes and lose our shirts.
There are three types of investors during a stock market crash – those who sell, those who do nothing, and those who buy more. Which type are you? If you don’t already know then this can be an expensive time to find out. We learn the most about our investment behaviors when the market is tanking, not when it’s rising.
The global influenza pandemics of the 1950s and 1960s killed more than 1 million people each time. But eventually the world moved on and financial markets recovered. It’s a bit counterintuitive, but profits are made when you buy, not when you sell. This is because the price you pay for an investment is the main factor that will determine your future profit.
How to buy into the dip
If panic selling is not a good idea, then what can we do? Here are a few common strategies to consider:
- Rebalance approach
Although most securities are down, government bonds and other fixed income funds like (VSB.TO) have gained. Sell some of these low risk assets to buy beaten down stocks. But do it gradually. This also helps to rebalance your portfolio to your previous asset allocation.
- Gradual nibble approach
This requires you to have some cash saved up first. Every time the market falls by 10%, you put more money into the markets. Start with 20% of your cash balance. Go up to 30% of your remaining balance the next time. Then 40%, etc. This ensures that each additional time you buy, you are picking up stocks at lower prices.
- Wait for a bottom approach
Sit on the sidelines and wait for a sustained rally using technical analysis. Save and accumulate cash in the meantime. Store this cash in a high interest savings account or short term bond fund so it can be liquidated relatively quickly. Once market momentum starts going up again use 75% of the cash to buy stocks on the rise. Gradually buy more with the remaining 25% over time.
I don’t know which method works the best. But here’s what I’m doing:
As posted in my latest net worth update, I had about $150,000 in cash at the beginning of March – a very fortunate position to be in. 🙂 I’ve already spent about $80,000 of that buying into this bear market over the last few weeks. My most recent stock purchases were Suncor (SU.TO), Pembina Pipeline (PPL.TO), Canadian National Railway (CNR.TO), and Fortis Inc (FTS.TO). I’m buying even as prices continue to fall because the stock market is down 32% from its high so far. Historically 32% is the low point of the average bear market. Although stocks could fall further, investing about half of my cash savings now guarantees I don’t miss out on the upswing in case we are already close to the bottom.
I plan to deploy another $50,000 into the market after technical indicators improve. There are two primary signals I’m interested in.
- I’m waiting for the 10 day moving average to reverse direction from down to up.
- I’m looking for the MACD signal to improve.
These indicators can be applied to individual stocks, sectors, or entire indices. For example, below is the S&P/TSX index. We can see it is not yet time to buy.
A new bull market should start once we see price momentum swing up. 🙂 But this is speculation. Even after a short term bounce, there could be more downside before things actually start to turn around.
Beating the market with time arbitrage
Long term investors should view market pullbacks as opportunities, not setbacks. At any given moment the stock market only thinks 3 to 18 months ahead. However, individual investors can think much further ahead which gives us a tremendous advantage. 🙂 We can use the inefficient, short term market swings to buy high quality companies when they become oversold. Playing the long game is easier than competing with traders and analysts over short term outcomes.
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” ~Benjamin Graham
A stock’s “target price” refers to what analysts believe each share will be worth a year from now. Here’s an example for BCE, a major telecom business.
But analysts never provide five or ten year price targets. Ironically it’s easier to predict long term stock prices than short term. For example: I have no idea what BCE shares will trade at next week. But I’m pretty confident it will be a lot higher in seven years from now. Everyone needs a phone. Even Mr. Potato Head has a mobile device – incase Mr. Onion Rings. 😀
“If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people… Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue” ~Jeff Bezos
Having a long term investment horizon is the best advantage you and I have against Wall St.
Random Useless Fact:
Introverts are usually better prepared for pandemics than extroverts.
Hah, like the graphic at the end. Staying home is easy for me, though it’s a bit more difficult for my toddler who likes to have activities.
I’ve been buying more but used up probably about 30% of my cash reserve so far. Got a very small starting position of TD at $50! I’m doing the gradual nibble approach but not increasing my increments, just keeping it around $15-20K each time and trying to limit myself from investing to every 1-2 weeks.
That’s great you managed to get TD at $50. If that was the bottom of this bear market cycle then you’re the best stock market timer ever, lol. 🙂 I remember when I first started investing and felt nervous when I put $1K or $2K at a time into the market. Now I throw $5K or $10K around like it’s no big deal because the new purchases are not much compared to the overall portfolio size as a whole. I try to limit myself to not buy too frequently as well. The hardest part for me is being patient through all of this.
I’ve been taking the nibble approach right now. Until more information is available, I’ll continue to nibble to strong dividend growth stocks. THe hard part with approach number 3, waiting for the bottom, is who knows when that is going to be. What if you think you hit the bottom, but then cases spike, more companies lay off employees, and the economy craters. It sounds a lot like trying to time the market, which is just impossible to do and succeed at in the long run.
Thanks for the thoughtful read tonight.
That’s right. Only in hindsight can we see when the market has bottomed. Before that it’s just guesses. The historic time we’re in now will be a great learning experience for many investors. 🙂
I’ve also been dipping into these markets, although I’m at a much earlier place in my investment timeline. I was also watching Pembina Pipeline; I ended up picking up a bunch of Inter Pipeline for dirt cheap and am looking forward to where they will be in a few years. Dollar-cost averaging helped in easing into my position.
Thanks for sharing your updates, it’s always nice to read level-headed analysis instead of all the crazy clickbait market news that’s flooding in. I’m going to lose it if I see one more “Biggest drop/gain since X date” headline
DCA works best with companies that pay dividends because you get paid to wait for the stock price to go up again. Inter Pipeline looks to be in a good position to go up with the next recovery. And the dividend yield looks really attractive. One reason I decided to invest in Pembina is because the top level managers were buying up the stock. They wouldn’t have done so if they didn’t believe in the long term prospects of their company. I think pretty much all pipeline and energy stocks will be in much better shape a few years later. 🙂
Great post. What are your thoughts on using leverage to take advantage of the current prices once you have rebalanced and deployed savings? Rates are so low that it’s hard to not want to take advantage. If so, how would you go about determination amount to borrow, and which accounts to use (RRSP, TFSA, Non-Reg).
Good question. Generally I would not consider using leverage until the market has dropped by at least 40% to 50%. For now my plan is to use up my cash savings first. So far I’ve spent about $100K of it already over the last few weeks. I still have $40K of cash remaining which I will use up if stocks go down further, by another 20% or so.
Afterwards if the market falls even further then I will start borrowing money to invest. I will probably deploy $20,000 using margin debt to buy stocks each time the market drops by another 10%. By that time not only will borrowing rates be even cheaper, but the chance of stocks rebounding will be higher. The market can’t drop to 0. So the more it falls, the more room it has to bounce back up. Given that all bear markets in history was followed by new all time highs, I will assume the same thing will happen this time.
[…] But this type of thinking, although understandable, can lead to some costly mistakes. That’s why I suggest a more rational approach to managing money. First, we should realize that this time is not different. This isn’t the first worldwide economic shock. And it won’t be the last. Given the assumption that things will go back to normal we next have to look for opportunities in financial markets – where we can find mispriced, long term assets. So when stocks fell 30% earlier this year I suggested it was a time to buy, not sell. […]