Successful investing means keeping a level head in all market conditions, including the peaks and troughs, both of which can be unnerving, albeit for different reasons. When stock markets plummet or just plateau, investors can feel nervous about just how long this downturn will last and what impact it will have on their income and/or their prospect for capital gains. On the other hand, when stock markets surge, some investors might start to feel concerned about the prospect of a crash and start asking themselves if they should sell up in anticipation of it. It’s true that some peaks can end in crashes, but it’s also true that these tend to be the exception rather than the rule.
The difference between visibility and frequency
Given that the last major, global, financial meltdown was only in 2008, it’s probably safe to say that if you’re old enough to be reading this, you’re almost certainly old enough to have lived through at least one instance of a market reaching boiling point – and then cooling rapidly. You may remember this as a stressful and painful experience, but the fact that you are reading this means you did survive it and you did get a chance to see the market recover, so you know that even though market crashes can be highly unpleasant, they not only don’t have to be fatal, they can actually provide opportunities for astute investors. All that said, however, in this context, the key point to note about market crashes is that while they are, by nature, highly visible, they are also very infrequent and are by no means an inevitable consequence of stock markets reaching new highs.
The realities of stock market highs
Most stock market highs are like athletes in peak form, great, but not necessarily groundbreaking. Occasionally, stock-markets achieve “all-time highs” and these are like sporting records. They are certainly achievements but the difference between the new record and the next-best performance can be very small, in fact the difference between the new record and the general performance of elite athletes can be much smaller than you might think from the excitement typically generated by the announcement that a new record has been set. Over time, that record may well become the everyday normal and eventually become a standard that elite athletes are expected to surpass. One great example of this is the 4-minute mile. Back in 1954, Roger Bannister managing to run a mile in under 4 minutes was literally a historic moment and his achievement is still lauded today even though running standards have improved to the point where elite female marathon runners are achieving times equivalent to an average of 5 miles a minute over a distance of 26.2 miles. Similarly, most stock market “all time highs” are often only slightly higher than the last all-time high or even the standard performance and will usually wind up being superseded by the next “all-time high”.
The practical implications for investors
Investors need to expect the stock market to have peaks and troughs and, hence, prepare for them by making sure that they are appropriately diversified both within the stock market and across their broader investment portfolio. At this point, it’s worth highlighting that the principle of diversification sits on top of a solid investment-picking strategy and assumes that you aiming to invest in stocks which both have robust fundamental values (such as healthy cash flow and good balance sheets) and which fit in with your overall investment strategy, whatever that is. It can be highly dangerous to use the principle of diversification as a justification for investing in stocks you would otherwise have been forced to pass over as unsuitable.
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