by Lesley Scorgie / illustration by Jessica Lucas
The Canadian dollar is up, Alberta’s oil and gas royalty rates are set to increase, the real estate market is slowing down and financial sector pros are debating whether stock market prices have peaked. The winds of economic change are blowing, making waves throughout Canada. Now, I’m no scientist, nor am I an expert on evolution, but I understand and agree wholeheartedly with Charles Darwin’s concept of change: “It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change.” As unsettling as change can be, investors have a choice: learn to ride the waves or risk their ship capsizing, a very costly prospect.
Navigating and adapting to shifts in the market doesn’t have to be painful. Rest assured, economic and stock market cycles (expansion, peaking, retraction and the trough) are completely normal. You will survive. In recent years, we’ve experienced smooth sailing with above average returns from investments such as real estate, growth stocks and value stocks. Heading into a new phase in the economic cycle, however, we must sail cautiously.
A friend of mine, Angela, is a 29-year-old who works in the occupational healthcare field in Calgary. With investments worth $10,000, she’s ahead of most of her peers; the average savings for people her age is $2,500. Changes to the value of her small but growing portfolio can be disheartening and inconvenient, especially since she hopes to buy a home soon. As much as we’d like to set them aside, emotions tend to direct the behaviour of many investors. When the market environment changes, some investors buy or sell based on emotion – typically at the wrong time. Though uncertainty and change can invoke fear, it’s in your best interest to make decisions based on facts. And here’s a key fact: investors who don’t have a plan and hop from one investment to another historically earn a 4% rate of return, while those who stick to a plan and invest for the long haul typically earn to 10% to 13%.
When markets change, investors can respond by altering their philosophies – change the course of your ship (your destination). Or they can change individual investments – the way you’re driving the boat (your technique). Regardless of your risk tolerance and investment goals, it’s much easier to adopt a guiding philosophy, allowing you to stay the course while altering individual investments within your portfolio. The cyclical nature of the market has generated a few distinct strategic responses to change: Buy and Hold, Industry Rotation and Value Investing.
The Buy and Hold strategy means investors buy stocks and don’t trade them, which allows for appreciation. Stock market prices tend to rise over the long term (hence the rationale to buy and hold). Regardless of short-term ups and downs, the bright side is the potential for long-term growth. This approach to change is fairly conservative and works well for people whose objective is to match or slightly outperform the pace of the market.
The Industry Rotation approach is much more active. The objective is to outperform the market average while remaining within your risk tolerance. When stock prices rise and fall through their cycles, industries that are cyclical, such as forestry and mining, tend to increase and decrease more than defensive industries like utilities and banking. In other words, when times are good and the stock market as a whole rises, the rewards tend to be greatest in cyclical industries. However, when the market slows, these industries take the greatest hit. Therefore it makes sense to transition your portfolio towards high growth cyclical industries when the stock market is headed for an upswing and switch to defensive stocks when the market is expected to take a downturn.
Value Investing is a uniquely active strategy. Investors look for opportunities to purchase securities that have been badly “beaten down” and undervalued, which may be a result of cyclical market changes or other business dealings. Some investors base their guiding principles on bargain buying – my favourite type of shopping! To execute this strategy, investors must first understand and pay close attention to businesses facing short-term struggles. If it appears that a company can overcome a challenge (and the research supports this), then an investor may be able to take advantage of lower share prices. For example, Research In Motion (maker of the BlackBerry) was having patent problems a few years ago. If you invested in RIM at that time, you’d have saved 20% to 30% on its share price. Ideally, if an investor believes a company can overcome short-term struggles, they can experience significant growth.
If you choose to try any of these strategies, do your research first. Newspapers, magazines and financial websites can be wonderful sources of info. Remember, you’ve got to know where your destination is and when you want to get there. You can’t control the direction of the market; that would be like trying to control the weather. But you can control how you deal with your own investments amid larger changes. U
Lesley Scorgie is the author of Rich by Thirty: A Young Adult’s Guide to Financial Success (Key Porter Books). Need financial advice? E-mail lscorgie@unlimitedmagazine.com and we’ll bail you out in an upcoming issue.
Category: Money
