There is without a doubt a correlation between the decline in the markets during the past few years and the increase in suggestions by the experts to review or change the age-old investment strategies. They imply that using new or different strategies would have made a difference or that the nature of the market has evolved and therefore so should the practices used to asses it.
Is this a valid perspective or do the old strategies stand the test of time and the 21st century? In this article we will review five of the key strategies and investigate whether they are still work post-recession and credit crisis.
1. Buy and Hold
For those who were in ‘buy and hold’ positions 2009 demonstrated the pain that investing in the markets can bring. It was in that year that the declines of the previous years combined to wipe out all the gains of the previous decade. In general 2007 and 2008 alone generated 50% losses on investments being held. Does this mean that buying and holding is the wrong approach to investing?
Consider the fact that the markets have a history of going up and down and have historically always recovered from crashes like in 1987 and bear markets such as in 1990 and 2000 to 2002. No matter how deep the recession or the market falls there is always an upswing. The real key is how long it takes and how long you need to hold on for the turn to positively influence your portfolio. Taking advantage of the downturn to enhance the holdings and accelerate your profits by using dollar-cost averaging is the way to counter-balance the effect of the bears.
2. Risk: How much can you take?
So what was your response as you watched the markets go against you? Did you instinctively close out your positions, or sit and wait it out or see it as an opportunity to buy in more stocks at lower prices? How you reacted indicates your true tolerance to risk and your management of the risk management that you had in place.
Post-recession and market recovery is a good time to reassess your appetite for risk and your overall portfolio status. Depending on your long term targets it may be time to reconsider what constitutes risk and what risk you can tolerate. Ideally if you need to speed up your gains to reach your goals then it is worth looking at either changing the goals or identifying where you can take on more risk. Either way, risk management is as valid today as ever.
3. Portfolio diversification
The recent years, 2008 especially, broke the rule that diversification was the key to protecting against market downturns. The entire world get stung and practically every investment vehicle was affected from real estate to bonds, hedge funds to commodities and all types of stocks. Cash and U.S. Treasuries were the only options that didn’t get hit.
So does this mean you shouldn’t bother with diversifying your portfolio going forwards? Well the fact of the matter is that whilst all areas got hit some were less affected than others and thus helped contain the losses. Also the upswing is quicker from some than others and a diversified portfolio means that you have established the greatest opportunity to benefit from the gains while others sort themselves out. The best example of this was 2009 when fixed annuities gave a better return than other investment vehicles and showed how allocating a part of the portfolio to certificates of deposit (CDs) or fixed annuities can help protect against bear markets. This provides the confirmation that a diversified portfolio remains a valid rule to follow in the future.
4. Selling: When to do it
Long term strategies are good and remembering that the markets go up overall is essential to keeping a level head. However, there are downturns, the markets can be affected by all sorts of elements and expecting your investments to just keep growing and growing unhindered is unrealistic. Therefore setting times and prices to buy in and sell out is good strategy and taking profit without being greedy is the best approach. Also, even if your price target has not been met, if there appear to be issues with the underlying company or industry then there is sense in closing out position and profit taking while you can.
5. Leverage requires caution
In 2007 the subprime mortgage and credit crisis hit the world and with it came a backlash against leverage. The evidence was and still is very strong that using excessive amounts of credit to buy complex investment vehicles is high risk and thus not sensible. However, leverage as a concept still has its place, especially if used to help maximize returns and not to take excessive risk. I.e. using leverage for buying something like options to hedge a portfolio is valid and indeed recommendable. Whereas ‘dabbling’ in high risk commodities such as coffee with maximum leverage is not.
Investor Assessment:
So has anything changed? Each one of those rules remain as valid today as ever, indeed some have even had validation of their function. Experts will continue to disagree with each other and demonstrate how the markets are to be followed and can’t be steered or fully predicted. There are numerous instances such as the dotcom era of the 1990s where the experts predicted that they would continue with unlimited opportunity. Or more recently when many believed that the markets of Asia and Europe wouldn’t suffer as a result of the subprime mortgage meltdown, without consideration of the far reaching effects of banking and financial institutions. Today the market keeps going, some areas still in a bull market, others in a bear market but all as ever so why would you change the rules that help keep you protected within them?
