How to Protect Wealth in Volatile Times
HOW TO PROTECT WEALTH IN VOLATILE TIMES
This year has been a difficult one for Canadian investors.
The TSX Composite index is down almost five percent for the year, one of the worst performances among developed markets. The energy and commodity sectors have registered double-digit declines so far in 2015, while former stock market star Valeant Pharmaceuticals has flamed out with a 36 percent plunge in October alone.
Although some relief has been provided by the global stock market rally that could make October 2015 the best month for equities in four years, don’t expect a return to the steady upward trend that was a feature of the markets from 2012 to 2014.
The global bull market is now well into its seventh year. Its longevity can largely be attributed to unprecedented monetary stimulus by major central banks around the world. Other factors that have contributed to the boom include buoyant mergers and acquisition activity that could set a record of over $5 trillion this year, and record share buybacks in the U.S.
But the law of diminishing returns is now setting in with regard to these positive drivers, as investors fret about issues like the possibility of cheap money causing asset bubbles, stock valuations, the fallout from a slowdown in China, etc.
This could mean that once the seasonal strength that typically characterizes fourth-quarter action tapers off, market volatility could be back in a big way.
If the gyrations of September and October kept you awake at night, use the current rally to put into place measures to protect wealth, some of which we list below.
- Invest for the long term: This is a fundamental investing principle, but investors tend to regard it as a glib assertion by market professionals, rather than as a cornerstone of investment strategy. Investing usually produces positive results over the long term, but this means that an investor has to ride out intermittent market volatility instead of succumbing to panic and getting out at the lows. For example, towards the end of September, the Dow Jones Industrial Average (DJIA) was down 9.85 percent for the year; had it closed 2015 out at that low, it would have been the third-worst annual performance for the DJIA since 1977. An investor who abandoned the long-term investment premise and got out at the lows would have missed a huge rally in the DJIA over the next month.
- Rebalance your asset mix: If the vast majority of your wealth is tied up in real estate, and all the talk about a housing correction in Canada has made you nervous, consider rebalancing your asset mix by reducing your exposure to real estate. With regard to your investment portfolio, check your holdings and sell off any hot stocks that may go cold in choppy markets.
- Diversify your holdings: Unfortunately, most Canadian investors tend to invest in Canadian stocks, and do not pay much heed to overseas opportunities. This can be a costly mistake at time like the present when the Canadian economy and market are floundering. For example, in the five years ending October 15, 2015, the TSX generated annual returns of 4.9 percent. In comparison, the S&P 500 had annual returns of 13.9 percent over this period; and because the Canadian dollar tumbled against the U.S. dollar, returns from the S&P 500 in Canadian-dollar terms would have been 19.6 percent annually. What this means is that while $100,000 invested in the TSX over the past five years would have grown to about $127,000, it would have grown to $245,000 or almost twice that amount had it been invested instead in the S&P 500.
- Hedge your downside risk: There are plenty of avenues now open to the retail investor to protect their portfolio from downside risk. This can be achieved through a combination of inverse exchange-traded funds, short selling, and put options.
- Employ a professional: If you would rather spend your time creating wealth than devising hedging strategies to protect it, consider employing an investment professional. The modest amount it costs to get professional advice for your investments will be money well spent when the next downturn hits, as it inevitably will.
