What an extraordinary year this has been for the financial markets, the banking sector and the global economy as a whole. Low global interest rates in recent years have helped to create a bubble in asset prices, along with materially higher lending levels, and many would say that what we have seen this year is the inevitable outcome of such free market conditions.

The western world has been living beyond its means and the bubble has burst. The fundamental fallout from the crisis has been severe, and has been felt in markets around the world. It is highly unusual that all asset classes (shares, bonds, commodities, property) move in the same direction at the same time. However, they all fell in September and October.

Time To Buy?

For anyone with a medium to long-term time horizon (i.e. not requiring access to the capital before then), there are huge buying signals flashing at the moment. It is an unfortunate feature of investment however that many people tend to panic and sell out of shares or funds when they see prices falling. Similarly investors will sometimes sit and wait on prices to move up before buying in, by which time of course they have missed most of the gains!

Most market commentators, and experienced investors such as Warren Buffet (ranked by Forbes as the richest man in the world during the first half of 2008 with an estimated net worth of $62 billion), agree that markets are now looking very cheap and that we are in the final stage of the “bottoming out” process. In fact, he wrote an excellent article about this in the New York Times (click here).

Anthony Bolton, of Fidelity Investments, and recognized as the UK’s top fund manager over the last 20 years, said recently, “The bear market is looking mature, and a good part of the fall could be over.” He has started to feel optimistic again about shares for the first time in a couple of years. (A "bear market" is a period of declining prices).

Historically, stock markets rise quite dramatically after the “bear market" has ended and therefore people who have already invested stand to benefit and could make substantial gains. Remember that markets are typically looking at prospects for company profits around 6-12 months ahead, and therefore tend to recover much quicker than economies in general.

This is borne out by research which shows that markets actually tend to perform very well DURING a recession, as they are looking ahead to the recovery phase. For example consider this research by Seven Investment Management; Looking at recessions going back to 1949, US equities have returned an average of 17 percent in the recessionary period, while the UK FTSE All-Share grew by an average of 16 percent in the recessions of 1974-5, 1980-81 and 1990-92.

This is simply because markets are looking ahead, and have already suffered steep falls during the period BEFORE recession. As it now looks as if the western world is slipping into a recession (officially classified as two consecutive quarters of declining GDP), the evidence suggests that markets will start to rise before the real economy. 

How To Buy

So if you have a time horizon of more than 5 years then it does make sense to look at taking advantage of low market prices today. Remember that the time period is the key: the longer the time horizon, the more likely it is that equity investments will outperform other asset classes.

1. Drip-Feeding    

By investing an amount of money each month, or taking a lump sum and dripping it in at different intervals, it tends to smooth out market volatility. This is because if the price of your investment falls then you can pick it up at a lower price next time. This is also sometimes called “unit cost averaging” and is a popular way to dip your toe in the water.

2. Use Collective Investments

Buying shares in only one company is considered high-risk, simply because it is dependent upon the fortunes of only one firm. Most people these days will use collective investment funds, sometimes called “mutual funds” or “unit trusts”. These are a basket of different shares, managed by a professional fund manager, thereby substantially spreading the risk. There is a huge range of funds available, tailored for different global markets and sectors.

Funds with capital protection are also available, where your money is guaranteed not to fall but you can share in the upside potential. Be sure however to check for lock-in periods and accessibility.

3. Be Disciplined

Financial planning should be taken seriously and having a plan and setting goals will help you to gain control of your investments. Decide on your time horizon, be disciplined about how much you want to save each month, and stick with the plan.

4. Diversify

This is one of the golden rules of investment, going back to the old adage of “not having all your eggs in one basket”. A well diversified portfolio of investments will include exposure to different asset classes (equities, bonds, property, commodities and cash) however even within these classes, make sure you are not over exposed in one sector (for example, having all your equity funds in the UK).

5. Take A “Holistic” View

Don’t ignore other areas of your financial planning. Investing is just one part of it and you should ensure that other priorities (insurance, tax arrangements, education fees, mortgage) are dealt with. It makes sense to consult with a licensed independent financial planner, who will help you set your goals and objectives and help you structure your financial arrangements.

24 November 2008

Craig Welsh

Craig Welsh is an independent financial planner at the Spectrum IFA Group in Amsterdam. For further information, or to arrange a free financial review, please feel free to contact him at (craig.welsh@spectrum-ifa.com) or visit www.expatfinance.nl

Wall Street Sign. Author: Ramy Majouji, Wikipedia