By: Barry Choi
If last week’s minor sell-off wasn’t bad enough, investors woke up Monday morning to some brutal numbers. Chaos might be putting it lightly: there were huge losses at the start of the trading day (since then, some of the markets have had a minor recovery). No one knows exactly where the markets are headed but let’s take a look at what’s happened so far:
- The Toronto Stock Exchange dropped as much as 750 points
- China’s Shanghai Composite crashed by 8.5 epr cent and is already being called China’s Black Monday”
- Every major European indices are down
- Every stock in Britain’s FTSE 100 is currently in the red
- Oil is now trading at just over $38 a barrel
The Chinese Impact
Why exactly are the markets going down? There’s no concrete answer here, but it’s easy to blame China. Remember, just a few weeks ago they devalued their currency. When a country like China starts messing around with the markets, it freaks people out.
Sure, it could signal that emerging markets are going to see limited growth, but it’s much more likely that investors are scared and they’ve started to sell. Of course when the average investor sees the markets tanking, they in turn sell, creating a vicious cycle.
Last week I spoke about how to get over investor anxiety. It’s times like these where we’re really put to the test.
Make Sure You Have the Right Asset Allocation
Asset allocation is the mix between equities and fixed-income investments. Equities (stocks, ETFs) are riskier but potentially offer a higher return, while fixed-income investments (bonds, GICs) are safer, but have a lower return, especially in this low interest rate environment.
The conventional wisdom says your equities percentage should be 100 minus your age—so if you’re 25 years old, you should have 75 per cent in equities. If you’re 60, then you’re looking at 40 per cent equities in your portfolio.
To put it simply, the younger you are, the more risk you can take in your portfolio since you’ll have plenty of time to recover in the event of market volatility. Now if you’re approaching retirement, you want to make sure your investments are safer, hence the higher ratio of fixed-income.
Many financial experts believe even that ratio might be too conservative these days and recommend using 110 as your base number, or even 120 if you want to be really aggressive.
As long as you have the right asset allocation in your portfolio setup, it really doesn’t matter how the markets have been behaving. That being said, these giant swings might require you to rebalance your portfolio to get you back on track.
Also read: How to Assess Your Risk Tolerance>
Rebalancing Your Portfolio
Regardless of what the markets are doing, it’s just as important to rebalance your portfolio at least once a year. Rebalancing is when you realign the assets in your portfolio to get back to your targeted asset allocation.
For example, let’s say your target asset allocation is 75 per cent equities and 25 per cent fixed-income. Well, with stocks getting crushed right now your overall allocation might be sitting at 70 per cent equities and 30 per cent fixed-income. To get back on track you would sell 5 per cent of your fixed-income and buy 5 per cent of equities putting you back at 75 /25 per cent.
Generally speaking when your asset allocation is off by 5 per cent or more, it’s time to rebalance.
The other advantage of rebalancing is the fact that you’re selling high and buying low. Think about this from a day-to-day perspective; would you rather buy eggs at regular price or when they’re on sale? These down markets are an opportunity to buy stocks on sale.
Dollar Cost Averaging Is Your Friend
You can even simplify your investing by making things automatic by dollar-cost averaging. Simply set your account to automatically purchase your investments on a monthly basis regardless of the price. When prices are low, you’ll end up with more shares, but when prices are up, you’ll be buying fewer shares. In the end you would have bought at the “average” price.
For example, you’ve set up your account to automatically purchase $100 worth of the TSX each month for the next three months. In August, the TSX is worth $33, so you have three shares. In September, the TSX is now worth just $25, so you buy four shares. In October, the TSX drops even more and is now worth just $20, but you were able to purchase five shares. In total, you have 12 shares at an average price of $25 each.
This is a proven strategy that reduces risk since you’ll average out your costs as opposed to making one large investment at the wrong time.
Above All – Remain Calm
As Warren Buffet once said “Be fearful when others are greedy and greedy when others are fearful.”
These downturns can be a buying opportunity, but as long as you stick to your financial plan, there’s no reason to panic. Of course there’s also nothing wrong with sitting back and watching this roller-coaster run its course.