Fidelity 04 Market Opportunities

MARKET OPPORTUNITIES & REGULAR SAVINGS PLANS

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FIDELITY

F U N D A M E N TA L S

‘BUY LOW, SELL HIGH’ – THE GOLDEN RULE OF INVESTING? Theoretically, to make money in the stockmarket you need to buy shares when prices are low and sell them when prices are high. Repeating this recipe for success should provide ever-increasing wealth.

Q 1

Sounds simple. And yet, if so, why are we not all millionaires?

A

For two reasons:

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Firstly, markets are not predictable and can move quickly and erratically in either direction.

Secondly, many investors fall into the trap of letting their emotions overcome sound investment decisions.

With this certainty of knowledge, it would be simple to buy during the period of low prices and sell at the market high a fortnight later, repeating this strategy every month and becoming wealthy in the process. But unfortunately markets do not abide by these rules in reality. Attempting to ‘time’ buying and selling decisions in the short-term is a dangerous game, and one that very few professional investors manage to perform successfully on a regular basis. This is because markets are erratic – they can rise gradually over a number of days before suddenly falling and losing the previous gains (see chart below). Unexpected news, either specific to one company or the economy as a whole, can greatly influence stock prices in the short term. ...instead of unpredictably

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Wouldn’t investing be so much easier if the stockmarket moved according to a strict set of agreed rules or guidelines over time? For example, imagine if prices rose in the first week of every month, remained steady for another week, before gradually falling back to the previous levels – and that this pattern was repeated again and again as per the theoretical diagram below.

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MARKETS ARE UNPREDICTABLE IN THE SHORT-TERM

If only the stockmarket behaved rationally... THEORETICAL ILLUSTRATION ONLY

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THEORETICAL ILLUSTRATION ONLY

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So if investing is so unpredictable, why should I bother at all? And how do people make money?

A

Simply by taking a different perspective

UNDERSTANDING INVESTOR PSYCHOLOGY It is human nature to have hopes and worries when it comes to our money. However, sometimes these emotions can take control of our decision making to our detriment. The two most powerful emotions when investing are hope and fear – and both can often derail sound investment strategies.

CASE STUDY: Fear Susan, 32, has a dream of buying a house in France by the age of 40 and holds a well diversified international growth portfolio. After an initial lump sum investment of €10,000 she has been contributing €500 a month through a regular savings plan over a number of years. After a prolonged period of solid returns, recent market volatility has seen the value of Susan’s portfolio decline by over 10% from its highest point. Fearing that she will lose more of her hard-earned money, Susan decides to cancel her regular savings plan and immediately sell her portfolio and move the money into cash. She believes that “there is no point investing in shares when market performance is so bad.” Analysis Susan’s behaviour has been affected by feelings of loss & regret. In Susan’s situation, the fear resulting from the decline in her portfolio outweighs the potential for near-term growth. Although Susan was previously comfortable with the risk associated with her portfolio, witnessing the impact of short-term market weakness on her portfolio has caused her to panic and make an irrational decision, which could be very costly for two reasons. Firstly, Susan has sold out at a time of weakness when the market is ‘low’, which is theoretically the worst time to do so. Her behaviour has ensured that she will now not be in a position to benefit from any near-term market recovery. Furthermore, Susan has abandoned her long-term investment strategy which may result in her not realising her dream as planned.

CASE STUDY: Hope David, 38, has been investing in shares for over 10 years. He initially held a well-diversified portfolio of equity funds in the mid-1990’s, which performed strongly for a number of years. However, David began to feel as though he was missing out on the rapid growth of technology companies, as his portfolio only had a small amount of exposure to that sector. Deciding that tech stocks were the best performers based on recent results, David sold his portfolio in 1999 and bought shares in a small number of speculative technology firms. After a few months of strong growth, the shares fell sharply in early 2000 and by 2003 had lost over half their total value. Frustrated, David sold out and decided to wait for the next ‘sure thing’ to make back his money. After watching the market carefully from the sidelines as it has risen strongly in recent times, David now believes that resources companies are the way to go, and invests his remaining savings in the mining sector. He also takes out an investment loan in order to make up the lost ground from his last unsuccessful foray. Analysis David is no longer applying sound investment strategies such as diversification and taking a long-term investment horizon, because he is being too hopeful. Acting purely on emotion, he is chasing a quick win regardless of the high risk involved. While he knows logically that chasing a recent strong performing sector is a foolish strategy, he is currently acting irrationally, clouded by his anger at previous losses. Even if he gets lucky and makes some money with this approach, would David then return to a safer strategy? Unlikely. Fuelled with confidence from his success he will probably continue to take larger and riskier bets, similar to a gambler at a casino, until he once again comes unstuck.

TWO SECRETS FOR DEALING WITH VOLATILE MARKETS RATIONALLY

2) Market weakness may present opportunities American billionaire Warren Buffett (pictured) is commonly referred to as the world’s most successful investor. For over 50 years, Buffett has continued to grow his fortune - not through complex strategies or a magic formula - but by adhering to basic investment principles in a disciplined manner.

1) Remove emotion with a regular savings plan How do you decide when to invest in a volatile market? A regular savings plan could be the answer.

When the US stockmarket fell following the ill-fated tech-boom of the 1990’s, many investors were selling their holdings in fear or watching nervously from the sidelines. Not Buffett. Applying the golden rule of investing - buy when prices are low - Buffett quietly went about accumulating over-sold ‘cheap’ stock in a number of stable, quality companies such as Gillette and Coca-Cola.

By investing a consistent amount at regular intervals, you can gradually ‘drip-feed’ into the market regardless of the price on any given day. This strategy is known as cost averaging and can help smooth out the effect of market changes on the value of your investment. The power of the cost averaging strategy is that it takes advantage of price movements, as you will buy more units when prices are lower and less when they become more expensive, as shown in the example below.

The market soon realised that quality blue-chip firms were unaffected by the tech crash and were still making excellent profits. As such, they quickly returned to their previous valuations. Within three years, the US stockmarket was up over 50% from its lows. Buffett, having selected better stocks than the market average, performed even better.

REGULAR SAVER – Invests €1,000 per month 30

80

50

15

40

10

30 20

5

10 1

2

3

4

5

6

0

Month

LUMP-SUM INVESTOR – Invests €6,000 in month 1 After six months investing, both investors have invested €6,000 but the regular saver has accumulated more units and has an investment worth more than the lump sum investor. Total invested Average price paid Total number of units bought* Value of investment

LUMP-SUM INVESTOR

REGULAR SAVER

€6,000 €20 300 €6,000

€6,000 €20 310 €6,200

Key facts about ‘cost averaging’: • Investing at regular intervals smooths out highs and lows over time • In a fluctuating market, cost averaging can allow you to benefit from buying more investment units when prices are lower

1600 1400 1200 1000 800

Buffett bought during market lows

and then enjoyed the strong returns over future years

600

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S&P 500 Index

Unit price (€)

60

0

1800

70

This example uses assumed figures and is for illustrative purposes only. *Fractional units ignored.

units bought

25

Units bought*

unit price

2000

Source: S&P Data: S&P 500 Price Index (US$). Basis: nav-nav.

Market lows – an opportunity

Example of monthly savings plan and ‘cost averaging’

So, next time the market falls, think rationally and remove emotion from the situation. As long as you have a long-term time horizon, view the short-term weakness as a potential opportunity for buying more equities at cheap prices. To make it even easier, managed funds managed by professional fund managers such as Fidelity do the hard work for you, by constantly reviewing the market for the best opportunities and investing on your behalf. You should be aware that past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and you may get back less than you invested. But remember, you can’t invest successfully if you don’t invest at all.

Fidelity only gives information about its own products and services and does not provide investment advice based on individual circumstances. If you are unsure which investment is right for you, you should contact a Financial Adviser.