Averaging down will help you recover faster
Jonathan Chevreau, Financial Post Published: Wednesday, September 16, 2009
After recoveries of 45% or more in major stock markets since the Crash of 2008, investors may well wonder how it is they're still not back to even.
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After recoveries of 45% or more in major stock markets since the Crash of 2008, investors may well wonder how it is they're still not back to even.
After recoveries of 45% or more in major stock markets since the Crash of 2008, investors may well wonder how it is they're still not back to even.
There are two reasons.
- One, broad markets are still below the highs reached before the crash.
- Two, the arithmetic of loss means a 50% loss followed by a 50% rise does not mean you're back to even.
In the current edition of Graham Value Stocks, Norman Rothery notes the bellwether S&P500 index fell 57.7% peak to trough in the bear market, not counting dividends. It has since surged 53.1% from its lows but it still must rise another 54.4% to regain that former high. Thus, it would have to move 136.4% from the bottom reached after the original 57.7% loss, a result Rothery concedes may shock those unfamiliar with "the tyranny of losses."
The math is more understandable in absolute dollars. If you invest $100 at a top and lose 57.7%, you have just $42.30 at the bottom. But any gains you enjoy subsequently are coming off a lower base. Thus, even a 100% gain of $42.30 brings you only up to $84.60 -- still $15.40 less than the $100 you started with. To get back to $100, you'd need a 136.4% gain.
This is the ruthless arithmetic that has investors 100% in stocks -- or worse, leveraged so they were more than 100% in stocks -- licking their wounds in bear markets. However, B.C.-based financial planner Fred Kirby says ruthless arithmetic can be made to work to investors' benefit if dividends are reinvested during declines. This dramatically cuts the number of years needed to recover from losses.
Opportunistic buying can be combined with rebalancing of portfolios to maintain a normal ratio of stocks to bonds. Thus, after the 1929 crash, investors who reinvested dividends and regularly rebalanced recovered in seven years, compared to 22 years for all-stock investors who did not adopt this dual strategy.
Vancouver-based financial planner and author Diane Mc-Curdy says younger investors who dollar-cost averaged into the market early in 2009 have already done very well. Older investors should be conservative and adhere to the rule of thumb that fixed-income exposure should equal their age: so a 40-year old would be 60% stocks to 40% bonds.
The more you had in equities during the crash and the more those equities were in risky segments of the market, the worse the arithmetic of loss. Here, the accompanying chart adapted from Rothery's newsletter is instructive.
In peak-to-trough terms -- with the trough in March 2009 -- the hardest-hit market was the MSCI Emerging Markets index, which fell 67.4%. By early September, it was still 36.8% below its highs, despite the fact emerging markets bounced back 93.8% from their lows. They still must rise a further 58.1% to get back to their former highs. If you're in an emerging markets mutual fund or exchange-traded fund, you're still under water. Of course, if you were prescient enough to buy more at the bottom, you've almost doubled your money on that portion of your bottom-fishing adventure.
A glance at your portfolio may reveal that if you did do what the fund companies urged and "went global" some years back, you're probably still hurting most in funds that track the MSCI EAFE Index: Europe, Australia and the Far East. While the EAFE index didn't fall quite as hard as emerging markets -- it fell a nasty 63.5% -- at this point it still has "the largest hill to climb," Rothery says. EAFE markets are still 39.1% below their peak and have retraced only 66.9%, leaving almost as much again -- 64.2% -- before unitholders feel whole again.
Even the TSX composite still must rise 39.4% to get back to its former highs: something most people realize intuitively since the TSX passed 15,000 before the crash and is now just above 11,000.
Tomorrow, we'll look at what recourses investors may have to recoup losses.
jchevreau@nationalpost.com
Read more: http://www.financialpost.com/story.html?id=1998122#ixzz0eY9tf2po
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