Wednesday, June 25, 2008

ready for the market crash?

A post by fellow Canadian blogger Million Dollar Journey titled RBS Predicts A Global Market Crash, got me thinking...

Let's say you had $100,000 portfolio invested in the stock market and you woke up tomorrow morning and S&P futures were down 300 points. Food and fuel costs were out of control, inflation could not be tamed, the housing crisis was worse every day, Bank of America announced another $15 Billion write down, China's GDP growth slowed to 2%. There is blood on Bay, Wall, Main, and several other streets including Dufferin and Wellington.

Later on in the day you see that the DJIA, TSX, and S&P 500 were all down about 40%! That's right, you didn't read that wrong, 40%. By the end of the day the value of your $100,000 portfolio had shrunk to $55,876!

What would you do? Could you stomach this? It's easy to sit back and believe in the virtues of buying when everyone else is selling, but could you really do it in the heat of the moment? Does it matter how old you are and what your time horizon is? Do you really not need the money? If you did need the money anytime soon should it have been invested in this fashion?

Personally I would like to think that I would be licking my lips and planning my next moves as I watch dividend growers like Procter & Gamble (PG), Toronto Dominion Bank (TD), and Johnson & Johnson (JNJ) drop to multi year and decade lows. Envisioning myself in this scenario right now I would be a big buyer for the days, weeks, and months to come after the crash. That being said, I'm 29 years old and I've been investing seriously for less than 5 years. I've never lived through anything even close to this type of event. There is always a chance that I could be frightened, afraid of losing my job, afraid of losing my capital, and downright pessimistic about the short, medium, and long-term future of the economy and of the market. As an investor, I believe you should always be ready for this type of event, if 'ready' means only ready in your mind.

I do believe that I am truly ready. I have the economic lifestyle, discipline, and mindset to be a buyer when fear rules the day maybe more than at any other time in the history of the stock market. Call it persistence, call it discipline, call it stupid, but knowing what I know and departing on the path that I've departed on, I feel that it's not just the only choice, but the best choice. How could you handle it?


Sarlock said...

Discipline is the most important thing to have when bad times arrive. To let our emotions of fear take over is to make a bad situation worse.

The chances of the markets taking a significant downturn (maybe not 40% in a day, but certainly downward) in the next 12 months are pretty good. The economy may be able to weather the storms and come out relatively unscathed, but there are a lot of things that are soon to come to roost (inflation, rising interest rates, potential credit default swap market collapse) that are going to test the economy. We're long overdue for a lengthy bear market and Canadian real estate in many cities (Toronto, Alberta, Saskatoon, Vancouver) is as nearly overpriced as many markets in the US were. Whether real estate crashes here or just enters a long period of zero or slightly negative growth is to be seen.

The stock market is not a place to invest short term. If you do, you are more likely gambling than investing. Trying to "time" the market is something that even the most highly trained professionals fail to do most of the time, so don't even bother. For us investment amateurs, dollar cost averaging through the up and down times is our best defense against short term market volatility. If you are putting $500 a month in to investments, you are likely going to be able to grab some nice deals at the bottom of the down cycles, more than enough to make up for the high prices you pay at the top of market cycles.

I lived through the real estate market crash of the early 80's as a young boy. We had a nice home in suburban Vancouver and were building our dream home on 2 acres of land. We bought the land and took out a floating mortgage as we built the home, intending to sell our current home once the new one was finished, apply the equity against the new mortgage and lock in the balance in to a 5 year closed.

Well, as many know, interest rates climbed to levels no analyst had ever forecast. The real estate market crashed. Our dream home suddenly turned in to a nightmare. Interest charges on the loan were astronomical, we could not afford them. We tried to sell the half finished house but the market was sour and there were no buyers left. We sold our dream home for far less than we had invested in it so far. We had to sell our current home to try and cover the shortfall, but we had to also sell our first home for less than we originally bought it.

So, less than a year after being high on the dream of living in the country in a beautiful 3,000 sqft home on 2 acres, we were homeless, living in a beat up rental home and visiting the food bank for our Christmas dinner.

Do market downturns happen? Can they be extremely ugly? Do they hurt the common citizen far more than they hurt the rich? Absolutely. Invest wisely and do not overextend yourself. The past is NOT a good indicator of what the future may hold. The future can hold anything. said...

Thanks for the mention MG. I agree, stay focused on the long term and buy strong companies when they get cheap!

Anonymous said...

its easy to quote Buffett on this greedy when others are fearful, be fearful when others are greedy...although this may be easier said than done.


sampson said...

This is all great, and we'll all see if we can stomach the downturn. I too am a young, 29 yr old investor, with a decent portfolio.

My only question to everyone is where will the new monies come from? My current asset allocation has only about 5-12% in cash and bonds. Certainly most of that will go into new buys, but where would the rest of the money come from? Sell the winners to chase value?

I guess since I am a 'never sell' sort of guy (unless fundamentals change) I don't want to give up some of my previous gains for new acquisitions.

Anyone out there with a defined strategy for coming up with more capital? Leverage? Margin accounts? Remortgaging?

Potato said...

I'm also finding it hard to be greedy while others are fearful.

It's giving me a bit of indigestion, but I'm not tempted to sell out and bail in the current market downturn, though I'm only mentally prepared for a ~20% downturn. I'm not quite sure what would happen if I was staring at a 40% drop.

I am definitely having trouble buying more at the moment, even though I see a few compelling values. Part of the problem is the same one Sampson (above) has: I've only got enough cash/non-stock left to buy one, maybe two more positions, and with the market going down so much so quickly (it's 2pm and the S&P500; is down over 2% today!) and with so much volatility, I just can't make the call that this is the time to use the last of the dry powder.

I've always been a little leery of leverage: it just seemed to be outside my risk tolerance. But if I was somehow convinced that we were close to a market bottom, I'd look into a margin account. It's being that sure that the worst is over that I find tough!

TheElegantInvestor said...

What scares me is the price of oil. While I am not a doom and gloom kind of person, I cannot help but to think that high energy prices will change the fabric of our societies. What happens to suburbs, globalisation, inflation, transportation (airlines, cars, ...), etc. Such dramatic changes will take time (longer than a normal recession) and be likely more painful.

FinancialJungle said...

The size of the portfolio makes a big difference psychologically. Losing 40% on $100k isn't so bad if you're in your 20's or 30's. Losing 40% on $1 million in your 40's can be frightening.

I'm a big believer in value over price. The thought of selling $1 for 50 cents keeps me in the game.

Dividends4Life said...

I must admit, I've been pulling for the market to drop a little more. PG is about $0.50 above my entry point. I've been trying to buy PG for quite some time and the numbers are just now starting to work for me.

Best Wishes,

Dividend Growth Investor said...

[...]The Money Gardener is analyzing a recent report from Royal Bank of Scotland in ready for the market crash?.[...]

Geoff said...

It's also important to remember that you only "lose" 40% of your investments if you sell them when times are bad. Otherwise it's all paper gains and paper losses (excluding dividend payouts).