Riding out the storm

Published in the Herald Sun, July 2010 by Karina Barrymore

If the boss of the United States central bank, Ben Bernanke, is still on edge about the global economy, what hope has the average Aussie investor of working their way through the maze?

Investing, buying a property or just making any financial decision during these uncertain times involves even more stress than usual. Companies that appeared strong and robust have fallen. Billions of dollars have been lost in Australia through unstable investment schemes and bad advice.

And even if your shares or your investments have survived the global storm, the chances are they are still well below value.

According to AMP financial planner Andrew Heaven, households should be aiming to "bullet proof' their finances. The best way to protect yourself from volatility and uncertainty is to be prepared for the worst.

Emergency fund

“Start setting up an emergency fund. This is to make sure you have enough money in the bucket if something untoward happens," Mr Heaven says.

"Typically this is about three months' take-home pay in a high interest savings account. This will let you ride out most emergencies such as unemployment, sickness or accident, or major expense such as replacing a car or hot water system.

"But remember a credit card limit is not an emergency fund," Mr Heaven says.

"It's really important during uncertain times to keep your level of personal debt as low as possible. Because if you think it's bad having personal debt to repay when you're working, imagine what it's like when you're unemployed," he says.

Investment debt

Borrowing to invest is even riskier when financial markets are volatile. "If you have a margin loan, make sure you have enough in your emergency fund to cover off a margin call.

"Avoid, at all cost, having to sell investments in distressed or falling markets," Mr Heaven says.

"Contracts for difference are basically a margin loan on steroids. Make sure you know what you're getting yourself in for.

"Educate yourself on what CFDs are, such as going to the Australian Securities and Investments Commission website. Also understand who your CFD provider is and read the fine print of all material."

Wise-owl equities analyst Tim Morris agrees. "My motto is to only ever invest what you can afford to lose and still live a comfortable lifestyle," Mr Morris says.

"As CFDs involve leverage, investors should ask themselves whether they can afford to place such large bets," he says.

The warning follows a push by investment watchdog ASIC to review the regulation and risks involved with these investment tools, which have been promoted recently as a way to hedge against uncertainty.

ASIC, however, warned that a $5000 investment in a CFD could rapidly turn in to a $100,000 debt, after just a 10 per cent fall in the value of the shares linked to the CFD.

And share prices are still falling, often rapidly and unexpectedly.

Share market

We have been advising clients to be net sellers so far in 2010," Mr Morris says. However, it depends on when you started buying as to how exposed you are to the current volatility, he says.

"A lot of our investors have put money in the market during 2009 and are sitting on some meaningful gains and have taken profits over recent months," Mr Morris says. "However, people just entering the market are not so fortunate. In these conditions you have to be a bit patient.

"The best time to invest is when the tide is on your side. "Ideally you don't want to be buying in to a market that is falling because you never know how bad it is going to get."

The issue with uncertainty and volatility, however, is that it can often pay one party a profit yet make a loss for another.

"Every new stock market cycle that comes along is driven by new themes and new leaders. It's almost always a different sector that becomes the new star performer," Mr Morris says.

"It might be time to capitalise that good fortune now, perhaps sell up, and be ready to wait and see where the next emerging star will come from."

Newcomers

If you've held back so far because of the global crisis and watched as asset and investment prices have fallen, does that mean it could be a good time to buy?

"There are some exceptions in a downward market where you can buy well-seasoned blue chips if you have a long-term investment horizon," Mr Morris says.

"But if you're only looking 12 months ahead you want to be sure that you are not trying to push a train uphill.

"You need to wait until you have a tail wind working to your benefit, so I'd suggest to wait for the dust to settle first. Sentiment can turn very quickly."

Recovery

As we near two years since the start o f the global crisis, even the experts don't know what is ahead.

When US Federal Reserve chairman Ben Bernanke told the world this week that the biggest economy in the world was still "unusually uncertain" it sent even more shocks across financial markets.

Economists and market watchers are now suggesting there will not be a complete "recovery" but that a new global balance will be established. The sentiment is echoed in Australia, despite our economy and financial system among the best at weathering the storm.

"You could be excused for thinking that the share market is like a rollercoaster at the moment," says fund manager Wealth Within founder Dale Gillham.

"Every time the market rises we then see a corresponding fall that wipes out the recent gains.

"This 'groundhog day' type performance has seen our market go nowhere in over two months, even though there have been some large moves both up and down.

"Given the condition of many of the world's economies and the uncertain future they face in coming years, we need to accept that the landscape of the Australian share market has changed.

“We are no longer in a long-term bull market and what worked before the sub-prime meltdown is unlikely to work now.

"Investors cannot continue to behave like fair weather sailors and hope for the best. Instead a well planned strategy is required, if they are to survive in the market over the next few years.

"Anyone who owns a stock in this market needs to use a stop-loss to limit their downside risk in the event a stock falls away.

"It's about deciding how much money they are prepared to risk at the time they decide to invest and being prepared to sell if the shares fall below that level.

"When looking for shares to buy stay within the top-100 listed on the Australian market, as these are the safest and offer the best opportunity to make a profit.

"All too often investors think they need to trade the penny dreadful shares in order to make money but there is nothing further from the truth."