Waiting in cash until share markets fall

As any long-term share market investor knows, markets can go up and they can go down. While most people view a falling market as a bad thing, some investors see it as a buying opportunity. After all, it’s better to pay, say, $60 for a share after a market dip than $100 for the same share at the market peak.

Of course, to be able to exploit these buying opportunities, the cash needs to be available. That means hoarding some extra cash while markets are happy in anticipation of a rainy day. It also means having a strategy around when to invest, how much to invest, how long to hold and what to invest in. There isn’t a single, off the shelf solution to this, but 58-year-old Barry provides an example of what the rainy day investor needs to think about.

How much?

Barry is a seasoned investor with a sizeable self-managed super fund. He has weathered several market slumps over the years, and when markets are trading normally, with low volatility, he is happy to build up a cash reserve of up to 20% of his fund’s value to be used when the share market goes ‘on sale’. The cash comes from dividends and distributions, contributions and realised capital gains.

When to invest?

With no hard and fast rules, Barry decides that if the market falls by 10 per cent he will invest 25 per cent of his reserved cash. For each further fall of 10 per cent he will invest a further 25 per cent, so after a market fall of 40 per cent, all his cash stash will be invested. This could occur in a short time period or evolve over many months of ups and downs. In some market corrections he may not use all of this cash.

What to invest in?

Barry has some favourite shares and if they fall significantly in value he will top up his holdings. However, he knows this involves more risk than buying the market, so most of his purchases will be of index funds.

How long to hold?

In volatile markets price movements can be sudden, dramatic, and in either direction. Barry’s strategy is to sell any shares that produce a gain of 20 per cent or more during the recovery phase. He also uses stop-loss orders to provide some protection from further sharp falls. Barry also limits himself to buying quality assets, and is prepared to hold them long term if the recovery is a slow one.

Barry knows his strategy isn’t perfect. If share prices don’t fall, he is left holding larger amounts of low-yielding cash than would normally be the case. If they fall a long way, he’ll miss out on buying at the bottom of the market. But Barry gains some peace of mind that if (or when) market corrections do occur, his strategy should provide some protection to his super portfolio and improve his long-term position.

Seek advice

This is just one example of a rainy day cash strategy. Everyone’s circumstances differ, and it is important to seek appropriate advice specific to your situation. Talk to your Bridges financial planner about a solution that’s right for you.

The upside of a market downturn

Most people view share market downturns as unequivocally bad events. Suddenly, hard earned savings aren’t worth as much as they were yesterday. It seems as if our money is evaporating, and in the heat of the moment selling up can look like the best course of action.

 

The alternative view

On the opposite side of each share sale is a buyer who thinks that they are getting a bargain. Instead of getting 10 shares to the dollar yesterday, they might pick up 12 or 15 to the dollar today. When the market recovers, the bargain hunters can book a tidy profit.

So why do share markets experience downturns, and what are the upsides?

A range of natural and man made events can trigger market selloffs:

  • Terrorist attacks.
  • Infectious disease outbreaks such as SARS and COVID-19.
  • Wars, the possibility of war, and geopolitical issues such as threats to oil supplies.
  • Economic upheavals, the bursting of speculative investment bubbles, and market ‘corrections’.

In short, anything that is likely to reduce the ability of a broad range of companies to make money is likely to trigger a market sell off.

The common thread that runs through the causes of downturns is uncertainty. In the immediate aftermath of the 9/11 attacks nobody knew what the size of the threat was and markets dropped. As the fear of further attacks receded, markets soon recovered.

However, the initial drop in market value occurred quite rapidly. By the time many investors got out of the market the damage was already done. Paper losses were converted to real losses, and spooked investors were no longer in a position to benefit from the upswing. After the initial sell off it took the ASX200 Accumulation Index just 36 days to completely recover from 9/11.

Other downturns and recoveries take longer. The Global Financial Crisis began in October 2007, and it wasn’t until nearly six years later that the ASX200 Accumulation Index recovered its lost ground. This caused real pain to investors who bought into the market at its pre-crash peak, but for anyone with cash to invest after the fall, this prolonged recovery represented years of bargain hunting opportunities.

 

If? Or when?

Of course much hinges on whether or not markets recover. While history isn’t always a reliable guide to the future it does reveal that, given time, major share market indices in stable countries usually do recover. It’s also important to remember that shares generally produce both capital returns and dividend income. Reinvesting dividends back into a recovering market can be an effective way of boosting returns.

 

Seek advice

Of course, it’s only natural for investors to be concerned about market downturns, but it’s crucial not to panic and sell at the worst possible time. The fact is that downturns are a regular feature of share markets. However, they are unpredictable, so it’s a good idea to keep some cash in reserve, to be able to make the most of the opportunities that arise whenever the share market does go on sale.

For advice on how to avoid the pitfalls and reap the benefits offered by market selloffs, talk to your Bridges financial planner.

Making sense of financial jargon

When it comes to all things financial, sometimes it seems like people are talking a special language. By getting your head around some of the words and phrases most often used in the financial sphere, everything should start to make a lot more sense.

To help you out, we’ve put together a glossary of some of the key terms in the world of finance:

Asset class: This represents a group of investments that share common risk and return characteristics. The main asset classes are shares (both international and Australian), property, bonds, fixed interest and cash. Each asset class will offer a different level of return and therefore have varying degrees of associated risk. Shares and property are higher risk investments, while fixed interest and cash are lower risk.

Bear market: This refers toa financial market in which shares are currently falling in value. It’s arguable exactly how much a market has to fall in order to be considered a bear market, but a 10 per cent loss from a high point is usually considered a bear market.

Bull market: The opposite of a bear market, this term is used when share markets are continually increasing in value.

Concessional contributions: These are super contributions made from your pre-tax income and are generally taxed at only 15 per cent instead of your income tax rate. They include your employer contributions, salary sacrifice contributions and if you are self-employed any contributions for which you can claim a tax deduction.

Diversification: A principle that essentially means ‘not putting your eggs in one basket’. Diversifying your investments helps to minimise risk and maximise returns. Not all investments perform in line with each other, so investing in a variety of asset classes allows you to spread your risk.

Dividend: This is a payment made by a company to its shareholders, generally based on the company’s profits.

Franking credits: These are the taxation credits passed on to shareholders (including super funds) from companies which have already paid tax on profits before dividends are paid.

Indices/index: Provide a general measure of share market performance and are used as an indicator of the general health of the market.

Investment risk: The chance of incurring a loss from an investment. Generally, the higher the potential return, the greater the risk of loss.

Managed fund: This is a good way to achieve diversification. A managed fund pools your money with the money of other investors which is then managed by a professional fund manager. A managed fund may allow you to invest in a variety of asset classes.

Nikkei: Japan’s performance index and contains 225 top companies.

Non-concessional contributions: These are super contributions made from your after-tax income. These are not subject to contributions tax upon entry into your super fund (since they have already been taxed through your income tax).

Preserved benefits: Super benefits that cannot be accessed until a specified age and situation, for example when you are retired and aged between 56 and 60, depending on your date of birth, or you have reached age 65.

S&P 500: This indicates the United States performance index and represents 500 of the largest corporations in America.

Salary sacrifice: An amount of pre-tax salary that you can decide to contribute to super instead of taking it as part of your regular cash salary. This is in addition to the compulsory super guarantee contributions that are made by your employer on your behalf.

Shares: Also known as equities. When you buy a share, you are buying a portion of that company. If that company performs well, as a shareholder, you benefit by growth in the value of the share and often also by receiving dividends.

Superannuation (super): The system where you set aside funds during your working life to fund your retirement. The Commonwealth Government supports this system by requiring employers to contribute super payments on your behalf and enforcing regulatory controls to keep your money safe.

The All Ords: This stands for the All Ordinaries index which is made up of the weighted share price of about 500 of the largest Australian companies and provides the predominant measure of the overall performance of the Australian share market.

The FTSE (referred to as ‘the footsie’): The FTSE is the UK’s performance index and contains 100 top companies.

Financial advice makes a difference

Hopefully, with this basic guide, you feel a little more familiar with the world of finance-speak. Nevertheless, we are always her to help decipher the jargon and to help you make the most out of your financial circumstances.

Call Bridges Lake Macquarie to make an appointment with a Bridges financial planner. Your initial consultation is complimentary and absolutely obligation-free.

Bridges Financial Services Pty Limited (Bridges). ABN 60 003 474 977. ASX Participant. AFSL No 240837. This is general advice only and does not take into account your objectives, financial situation and needs. Before acting on this advice, you should consult a financial planner.