Tuesday, October 28, 2008
Why we should invest in downturn market ?
In the wake of the turbulence of stock markets in recent months, unit trustinvestors may be tempted to either sell or buy. However, investors are advised toremain calm and practise dollar cost averaging with their long-term goals in view.When regional and global markets succumbed to panic selling in August 2007 and morerecently in January 2008, the severity and sharpness of the correction was largeenough to make unit trust investors ask themselves whether they should redeem now tostem further losses or buy more units at currently low prices. In fact, if theypractise dollar cost averaging, they need not concern themselves with these timingissues. Dollar cost averaging enables investors to automatically buy more units whenprices fall and fewer units when prices rise.It is especially during times of market volatility that individual investors shouldremain focused on their long-term investment goals and keep their emotions frominfluencing their investment decisions. A disciplined and methodical approach toinvesting is the key to long-term investment success.Unit trust investors are advised to buy and hold their investments for the medium tolong term. The buy-and-hold principle is based on the notion that a good investmentwill generate reasonably attractive returns over the medium to long term. This alsomeans that investors are able to distinguish between daily movements in the marketand the underlying long-term value of their investments. Professional fund managersbuy and hold for the medium to long term as they are prepared to wait patiently overseveral years for their investments to reach their intrinsic or fair values. For theunit trust investor, the 'buy-and-hold' strategy can also be applied by holding onto a well-selected unit trust fund over a period of at least three years.There are some investors who believe they can achieve superior returns by timing thepurchase and redemption of equity funds to profit from the stockmarket's short-termmovements. These investors are tempted to engage in timing the market especially inan environment where equity markets are volatile. Such investors who wish to makequick gains in the stock market by switching from one fund into another fund willoften be disappointed. Market timing strategies that are often recommended by'investment experts' have seldom been successful. This is because stock markets areinherently volatile and are impossible to predict with numerous factors, bothdomestic and foreign, affecting daily and weekly fluctuations in stock prices.Investors who wish to take a more active approach with their investments by timingthe market will expose themselves to many risks. In order to profit from themarket's short-term trends, the investor has to correctly predict the market's trendand its turning points.Without the appropriate skills to discern signals and time the entries and exits,the market timer may not only miss opportunities, but also potentially suffer theblow of rapid losses. Also with a higher frequency of fund switching, investors willhave to incur increased transaction costs.Investors who are concerned about market volatility are advised to practise dollarcost averaging as this strategy enables investors to focus on the long-terminvestment goal and not worry about the prevailing level of the market. Dollar costaveraging is simply investing a fixed amount of money in a financial asset (such asa unit trust fund) on a regular basis (monthly, quarterly, biannual) regardless ofthe market cycle. By investing a fixed amount on a regular basis, investors will buymore units when the market is lower and fewer units when the market is higher. Thisstrategy will produce a lower average cost of investment than the average marketprice over any given period.In addition, investors are also advised to rebalance their portfolios regularly atleast once a year to ensure that their portfolio allocation reflects theirinvestment objectives and risk profile. Thus if, as a result of an uptrend in stockprices, an investor's equity exposure has exceeded a level consistent with his risktolerance, he can trim a portion of the equity funds and switch into bond or moneymarket funds to rebalance the asset allocation accordingly. Maintaining a targetasset allocation reduces the risk that the portfolio becomes too concentrated in asingle asset class.In conclusion, unit trust investors should always focus on achieving their medium tolong-term investment goals. The practice of dollar cost averaging and regularportfolio rebalancing are effective tools that help investors remain focused on thelong term horizon and prevent them from over-reacting to short-term movements of thestockmarket.