If making money was easy, we would all be rich. That is how the popular refrain goes. But making money can be easy, provided we have the patience and the willpower to let our investments grow and mature over time.
Patience is key. That’s because there are no “get rich quick” schemes in financial markets (or at least, there aren’t any that we know of that are entirely legal). But in straitened times like these, there could be many people out there who will try to promise us a route to instant wealth.
To put it bluntly, the next few years could be tough beyond belief. Warren Buffett said as much at the annual shareholder meeting of Berkshire Hathaway. He warned that many of his conglomerate’s businesses could report lower earnings this year.
A crunch is on the way
Put another way, the global economy is in a real mess. Inflation remains stubbornly high, even after more than a year of interest-rate hikes. What’s more, central banks, rather than trying to stave off economic recession, could actually worsen matters by withdrawing liquidity that might bring about a credit crunch.
Consequently, it could take a while for many countries and, by inference, many businesses to navigate a path through the economic malaise. The upshot is that stock markets, which are often seen as a forward indicator of an economy, could remain in the doldrums.
So, what should we, stock-market investors, do? In theory, there are three clear choices – to hold out and wait for a recovery; sell our investments; or buy more shares.
Each option has its merits. But as no two investors’ financial positions will be exactly the same, there are no hard and fast rules that will apply to everyone.
Holding out for a recovery
Companies exist to make profits, or at least they should. If they don’t, they could eventually go out of business. So, the more profit that a business can make, the more valuable it could become. It goes without saying that businesses can have good years as well as some not-too-spectacular ones. In other words, profits can vary from one period to the next.
Over the long term, though, a good company’s profits tend to improve, especially if the business is well managed and is able to take advantage of the markets that are open to it. If we are invested in these good companies, then we should not be overly concerned if their share prices decline.
A share price is, after all, an indication of what the market expects from the company in the future. By implication, a fall in a company’s share price might suggest some degree of pessimism about the company’s future outlook.
But good businesses should be able to take necessary action to avert a downturn in their profitability. Just look at how many businesses are laying off staff. That should be a sign of hope rather than an indication of despair.
Sell the lot and head for the hills
There can be compelling reasons for selling our holdings in a company. First, the outlook for the company may have deteriorated irreparably, and the existing management may also be unable to address the issues it faces.
However, disposing of our shares is a drastic step and should not be taken lightly. It is also important to go back and review the reasons why we bought the shares in the first place. We can then decide if there have been significant changes that might give us reasons to alter our opinions about the company.
Second, we may be at that crucial stage on our investment journey when cashing in our chips could be a viable option. These could be for reasons of retirement, in which case less-volatile financial instruments might be preferable.
Go and buy some more
If we have investments that have already fallen in value, then buying more at lower prices could effectively reduce the average price of the shares that we own. This is known as “averaging down”.
That said, cheap rubbish is still rubbish. Consequently, while averaging down is mathematically indisputable, it will only make good financial sense if the fundamentals of the business are sound. These are businesses that can generate rather than burn cash, and companies that can grow revenue and raise prices in difficult times.
From an income investor’s perspective, down markets are an ideal opportunity to buy dividends at a reasonable price. But it is important to focus on companies with high returns on equity, businesses that have been able to meaningfully grow their payouts over time and have well covered dividend yields of at least 2 per cent.
Note: An earlier version of this article appeared in The Business Times.
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Disclosure: David Kuo does not own shares in any of the companies mentioned.