When it comes to investing, the adage “If it’s in the press, it’s in the price” rings true. The market, often praised as a stable, distinct entity, is made of those who participate in it—when investors react, so too does the market.
Investing is perverse, according to Gerald Connor, chairman and CEO of Cumberland Private Wealth Management. When markets are down, investors believe that risk is elevated. In actual fact, however, risk has been reduced since the sold-off markets include a “fear premium” or discount—prices drop as events happen, rather than after, and investors shouldn’t fear further loss once prices have hit bottom.
“When the market reacts, it’s already based on the past,” says Connor. “The times investors perceive as risky and volatile are actually less risky, due to the fact that prices have already dropped and will most likely start to rise once again.”
For example, an investor may have a stock trading at $30, which is expected to go down to $20 in recession. If a downturn is forecasted, the stock drops to $25 and risk is already lower. When a recession hits, and the stock drops to $20, shareholders really start to worry.
But at that point, the recession is already a reality and is reflected in the price. From this point on, the price will likely rise and the stock will be worth more than $20 in the near future, allowing investors to not only regain capital, but also make a profit.
Connor stresses that when investors are attempting to time the market, they must be confident, and aware that the market is not linear and is not based on the past. They have to step back, analyze current trends and avoid getting caught up in the emotions of the wider community.
He cites Warren Buffett as an example of someone able to achieve this and find the confidence to participate in down markets—Buffett invested $24 billion in the third quarter of 2011, when markets were at their lowest. Investors like Buffett can ignore group fear, because they “understand that risk is a perception and not a reality, and can view the market and risk differently than the average person.”
The question is: can fearful investors learn to overcome uncertainty and take risks?
“Knowing what to look for and having the skill and confidence to pick are two different things,” says Connor. “Younger people may not be able to execute, but those who have gone through tough times, and who know that the paradox of investing is consistent, are able to pull the trigger and recognize danger signs.”
But timing the market doesn’t mean investing without a plan…(click through for page two)