Waiting for corrections
TLDR: When to invest in the market? Yesterday!
“Far more money has been lost by investors preparing for corrections or trying to anticipate corrections, than has been lost in corrections themselves.” – Peter Lynch
Given my interest in personal finance, investing and of course FIRE, I am part of a few forums, subreddits and telegram channels that discuss these topics. One theme that seem to emerge after the bull run in Q1 2019 is that- “Have the market run up too much? Should I wait for corrections before deploying further cash into equities?”
This conversation evolved into a discussion of building up your war-chest of cash to deploy in case of correction (10% fall) / bear market (20 to 50% fall). One other interesting comment that came up was
“I have not invested in the stock market since the last crash in 2009”
I have seen my fair share of investors who got caught up in the pre subprime bull run of 2003 to 2008 and got burned pretty badly during the fall. They swore to never invest in the stock market again. Only to re-enter the market in 2014, missing all the low stock prices that come with the recession.
Peter Lynch had said the following about waiting for recession.
“Now no one seems to know when they are gonna happen. At least if they know about them, they’re not telling anybody about them. I don’t remember anybody predicting the market right more than once, and they predict a lot. So they are gonna happen. If you’re in the market, you have to know there’s going to be declines. And they’re going to cap and every couple of years you’re going to get a 10 percent correction. That’s a euphemism for losing a lot of money rapidly. That’s what a “correction” is called. And a bear market is 20-25-30 percent decline.
They are going to happen. When they’re gonna start, no one knows. If you’re not ready for that, you shouldn’t be in the stock market. I mean the stomach is the key organ here. It’s not the brain. Do you have the stomach for these kinds of declines? And what’s your timing like? Is your horizon one year? Is your horizon ten years or 20 years?
What the market’s going to do in one or two years, you don’t know. Time is on your side in the stock market.”
Two lessons from the investment guru.
Do not time the market
Do not wait for correction to invest
Pretty straightforward, isn’t it?
But does it mean that you should not hold cash? Other than basic necessities there should be no reason to hold cash. I would recommend the following approach If your typical investment ratio is 70:30, equity to debt.
Look at the historical average P/E earnings of your index and compare against the current P/E
If the current P/E is inline with the historical average then keep your DCA / SIP in the same 70:30 ratio
For every 20% move in either direction of the P/E do a 5 % shift in your ratio of equity to debt investment
For example if historic P/E of the index that you are following is 12
If current P/E moves to 14.4 (up 20% from historical average) , then your DCA/SIP should shift to 65:35 equity to debt
If the current P/E moves lower by 20% to 9.6, then your DCA/SIP should shift to 75:25 equity to debt
These are simple guidelines, you might want to tweak this ratio as per your risk tolerance
Never sit on cash, even if you want to build a war chest for the recession, keep investing based on the above formula.
With regards to which index to choose as benchmark - S&P500 in the US, STI in Singapore or NIFTY 50 in India based on where you are located. Use your regional benchmark index as a reference.
Sitting on cash waiting for a recession has never served anyone over the long term. If the equity market is overbought based on your calculations then shift more of your DCA/SIP to debt. But never sit on cash as cash gives you negative real returns. Make your money work hard for you.
Do you have any thumb rules when it comes to investing? What are your recommendation when the markets are white hot? How do you tweak your investments? Leave your comments below.