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Part Two — Market volatility: Why and how to make it work for you

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In Part One, I discussed some differences between the 1 per cent and 99.

How do the 1 per cent differ from the 99 when it comes to market volatility? Is there something the average investor can learn?

I’m not trying to defend the 1 per cent. What I am trying to do is point out that the market is public and that market volatility leaves no one untouched. No stone unturned.

I’m not here to talk about tax inequality or to defend either side. People like Warren Buffett have done that. There have been arguments for and arguments against Buffett.

What I’d like to focus on is:

While the 1 per cent have better intelligence and more powerful networks when it comes to investing, there are strategies the 99 can use to get ahead. Strategies Warren Buffett and the 1 per cent have been using for a long time.

If you’re a long-term investor, you can own a lot of the same assets. Granted, you may not get these assets at the same transaction costs due to scale, but you can own assets that should enrich you over time.

Have the wealthiest people sold all of their assets? Doubtful.

Do they sell them after market declines?

Well, let’s look at this rationally.

  • You need to find a buyer in order to sell your shares (the sheer scale of owning billions in assets means it’s harder to find a buyer when you sell)1
  • Liquidating such assets might cause some significant tax implications2
  • Because of professional counsel, the 1 per cent are exposed to more and better research than average investors, leading to fewer knee-jerk reactions in the face of market events

There would be barriers to the 1 per cent selling their assets.

Taxes …

You can see at least three articles above discussing whether taxes on investments and the 1 per cent are too low. There is definitely a movement afoot to examine these issues.

Let’s set the 1 per cent aside for a minute.

Remember, Joe Average gets a break on taxation for certain investments, too. So does his partner, Josephine. They may not get as big a break, but they do get a break.

They get a deduction for contributing to an RRSP. They get tax-free earnings in a TFSA. If they’re invested in dividend-paying equities outside of an RRSP or TFSA, they get tax-preferred income from those dividends.

Advice

Because the wealthy have the means to get good counsel when it comes to their investments and financial planning strategies, we can assume that those professionals counsel their clients:

  • To avoid panic selling
  • To rebalance regularly and systematically

Joe and Joe and Market Volatility

Now, what about Josephine and Joe Average? Are they taking advantage of the better prices presented through market volatility?

After the 2008-2009 correction, did the average investor take advantage of some of the cheapest prices we’ve seen in a generation? Is the average investor taking advantage of cheaper prices now?

Research says no. (Like to explore this idea further? I blogged about it in “Don’t Panic”.)

People concentrate on returns over a given period of time. But such assessments assume that you invested your money all at one time at the beginning of the period. How many investors do that?

Easy as ACB

Your Adjusted Cost Base (ACB), basically, how much you paid as you bought an investment, is a much more realistic measurement of how you’re doing.

If the broad market’s down 20 per cent, and you’re ACB is showing that your investment in a broad-based mutual fund or ETF has broken even, e.g. the investment’s price is 10 and your ACB is 10, you’ve done great.

Why? Because you’ve outperformed the market over the same period.

How did you accomplish this? By using excellent rebalancing strategies.

Of course, if you’ve had a more conservative position, you have to realize that when the market turns around, the broad index may start outperforming with respect to your investment. Your rebalancing plan will help with this, and sticking to that plan will help even more.

Figuring out who you are as an investor is important.

In Part Three, I’ll continue, focusing more on long-term strategy with a simple illustration of why that focus will make you a better investor.

Notes:

1The 1 per cent tend to buy shares of companies more than they buy mutual funds. Diversification isn’t as big a deal for them. They have the means to buy enough shares and still be adequately diversified. This isn’t true of the average investor. Some market experts say you should have at least a million dollars to invest to be adequately diversified when holding stocks. Others disagree. It’s true that the fewer companies you hold, the less diversified you are, and the more risk you’re taking on. Employees that held most of their investments in Enron or Nortel found this out the hard way when the stocks collapsed3.

2Taxation is another reason why the 1 per cent sell their holdings, e.g., experts have suggested Steve Jobs’ heirs sell their shares in Apple to avoid over $800 million in tax liabilities.

3More evidence for diversification comes by way of Bill Gates example. While he has significant wealth in Microsoft shares, he holds a lot of Berkshire Hathaway in order to further diversify his holdings. Forbes claims that more than half of Gates wealth is held outside Microsoft stock.

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