During downward economic cycles it is well known that "cash is king". However as many self funded retirees are experiencing, a drop in interest rates has an immediate negative impact on income generated from cash or fixed interest investments. Interest rates have been cut by 4% in the past 6 months. Term deposits rates are around 5% or less. With inflation, measured by the Consumer Price Index, at 3.7% investing your money at 5% or less will only just maintain its value and may even lose real purchasing power over time depending on your marginal tax rate.
So if you are cashed up and looking for better returns all you need to do is look for signs of an economic upturn and plunge into the market when you see them, right? Theoretically that is how it would work but reality is very different. For starters, what upturn indicators should you look for? If your indicator of the upturn is building approvals, for example, what percentage increase in approvals would indicate an upturn?
These rhetorical questions point to a basic principal the majority of honest investment professionals agree upon, "you can't time markets". To successfully time markets you need to get two decisions right; when to get out of the market and when to get back in. Sure some money managers get lucky on occasion but the evidence suggests that no one can consistently time markets. The media only report on what has already happened. By the time you read of the upturn in the papers it's too late.
As James Carlisle communicates in his entertaining article in issue 264 of the Intelligent Investor titled "Prudence looks for signs of recovery" his fictional character, Prudence, looks for signs of recovery from the recessions of the early 1980's and 1990's. She finds an article with the headline 'Recession: It's on the way out' from The Sydney Morning Herald on 21 June 1991 which took heart from a jump in home loan approvals and a marked increase in business confidence. Another article headlined 'Signs of economic recovery' on 12 June 1991 noted an improvement in the 'Westpac/Melbourne Institute index of economic activity'. But the thing that most struck Prudence was that this talk of recovery was going on in June 1991, yet the stockmarket had already risen 13% in the first quarter of that year, followed by 4% in the second. True to form, in the 1980s articles foreseeing a recovery had started to appear in the second half of 1983, yet the stockmarket had put in gains of 6% and 18% in the first two quarters of that year. Those watching the media reporting for an upturn will generally miss the boat.
Being out of the market on days when asset prices rise significantly can severely impact on your overall investment performance. As can be seen from the chart below, over the last 16 years if you were out of the market on the 15 best days (that is close to just one day per year) your return (annualised compound return) would drop 3.6% and return $2,380 less for every $1,000 you invested.
|PIC2|Economists and investment professionals with all the tools and resources at their finger tips cannot predict when the market is going to turn upwards (or downward) until it is too late. A more prudent approach to investing than trying to time the market is to use Dollar Cost Averaging and regular rebalancing to make the volatility in assets prices work for you.
Gavin Martin is a Financial Adviser, Managing Director of Cornerstone Wealth and founder of www.mastermymoney.com.au
Disclaimer
This article does not take into account the personal objectives, financial situation or needs of any person. You should consider the appropriateness of the information having regard to your own objectives, financial situation and needs and obtain professional financial advice prior to making any decision.