By Greg Boland
Don’t be scared of a bear market - this has happened before and will happen again.
Of the traditional asset classes – cash, bonds, property and shares – shares carry the greatest level of risk but also have the potential for generating the highest returns over the long term. Indeed, the average stock market return in the US has been about 10% annually since 1926.
However, a bear market such as the one that we are in now occurs when there is a fall of greater than 20% in a market as measured by a broad index such as the NZX50 or S&P500. There have been 17 bear markets in the US since 1929 and whilst scary at the time, dips such as this one provides opportunity to buy for the long term. Creating a balanced share portfolio for your age, investment time horizon and risk tolerance are paramount when investing in shares.
A bird in the hand or two in the bush
When it comes to investing, risk and reward are inextricably entwined. The common saying "no pain, no gain" sums up the relationship between risk and reward. Don't let anyone tell you otherwise: all investments involve some degree of risk.
Working out your risk tolerance is the biggest hurdle you must face when considering investing in shares. Risk tolerance is your ability and willingness to lose some or all of your original investment in exchange for greater potential returns. If you are not sure of your risk tolerance, perhaps ask yourself, would I rather invest in:
- A company that may make significant technological advances was recently listed on the exchange and seems under-priced;
- An established, well-known company that has a potential for continued growth (think Microsoft, Alphabet and perhaps Apple); or
- A 'blue chip' company that pays regular dividends and low levels of debt (think Banks and Utilities)
An aggressive investor, or one with a higher-risk tolerance, is more likely to choose companies 1 and 2, and is happy to risk losing money in order to get better results. A conservative investor, or one with a low-risk tolerance, tends to favour investments that will preserve his or her original investment such as companies 2 and 3 above.
Aggressive traders in shares are seeking two in the bush while more conservative investors prefer to keep a bird in the hand.
Don’t put all your eggs in one basket
Why not choose all three options above and create a diversified or balanced portfolio that has the potential for capital growth as well as income from dividends? Diversification across companies, themes, sectors and countries is easily achieved whether you invest through a traditional advising firm or via a trading app such as our Tiger Trade.
The process of determining which mix of assets to hold in your share portfolio is a very personal one. Ask yourself, which companies:
- Do you know and like?
- Pay a solid dividend?
- Have the potential for ongoing growth?
- Are likely to be around in 10 years’ time?
- Are a takeover target?
- Are market disrupters?
The allocation mix that works best for you at any given point in your life will depend largely on your time horizon and your ability to tolerate risk. This preference will change over your life many times but holding shares for a longer term is rewarding.
Have at least 8 companies in your portfolio. I have seen time and time again people who put all their eggs in one basket and get badly hurt – don’t do it!
Time in the market is more important than timing the market
Whilst pullbacks like what we are seeing now definitely provide opportunity, time in the market and the power of compounding returns longer term is far more important than timing your entry into the share market. If you are unsure about timing remember you don’t need to invest all at once and you can choose to drip feed to achieve a dollar cost average in your chosen companies.
Work out your investment time horizon – is it weeks, months or years, and even perhaps decades. Investors with a longer time horizon may feel more comfortable investing in riskier, or more volatile shares as they can wait out more challenging economic cycles and the inevitable ups and downs of share markets. However more aggressive investors are usually more focussed on a short-term quick fix when it may be more prudent to focus longer term. Those with shorter time horizons may find bear markets far more hazardous and may wish to take a more conservative investment view.
Benefits and Risks of Shares
So, what are some of the benefits of investing in shares?
Liquidity – the ability to buy and sell at will - compared to property is one of greatest benefits of shares. Higher returns as stated earlier and the ability to have a return above the inflation rate are also very important. Whilst US inflation is just under 9% currently (a 40-year high), over the long term the average is just over 3%. So, if you can achieve a 10% return then you have hedged inflation risk and generated a net 7% return. Dividend income whereby companies pay out a portion of profits can provide a regular passive income to share investors. Diversification and being able to start with a small sum are also of great benefit to share market investors.
There’s no such thing as a free lunch so be aware of the risks inherent in share trading and investing. Volatility and pullbacks of 10% from price highs happen every year, bear markets every 4 years or so and major corrections of greater than 30% usually once a decade (1987, Dotcom, GFC, Covid).
So don’t be afraid to invest in shares – the current period of higher risk presents opportunity but diversify and try not to time the market especially if you have a long-time horizon.