Making the best use of lemons
An old-time saying goes "when life throws you a lemon you make lemonade" which means you make the best of a 'bad' situation. It is hard to follow this rule of thumb, but it will enhance one's way of living and how certain situations are handled. We always hope for the best when we enter into an investment, however, unpredictable market conditions can change any outcome. How can change be managed without losing your hair? Are there any steps to make the best of an unforeseeable adverse change in market conditions?
A strategy should be in place in order to invest prudently. That includes having a plan for when investments do not perform as well as you would have hoped. Investing requires diligence and action. A decline in the performance of one's investment may be caused by macroeconomic or microeconomic factors. If the underlying factor is determined, then the course of action becomes a little easier to establish. Macroeconomic factors are large-scale events or trends which affect the economy (for example recession and unemployment) while microeconomic factors are concerned with individual agents affecting the investment (such as pending lawsuits or regulatory investigations of a company).
Macroeconomic factors affect many things and are therefore closely monitored by governments, businesses and investors. A good rule of investing is to establish a "loss limit price" i e a price at which you will sell your investment, should it fall to that level. If an investor owns a security that is adversely affected by particular macroeconomic events, he/she should be on the lookout for changes in market conditions and data that signal the onset of such an event. The course of action could be to sell all or part of the investment depending on the event that occurred and the outlook for a reversal.
If an investor's comfort level is being threatened and the fear of potential financial loss is consuming the investor, then the decision to sell may be the best course of action. An investor may also decide to sell only a part of the investment for more than one reason. One being, they would like to safeguard a portion of their investment given the market conditions. However, this said security may be one that the investor believes could improve in the future as soon as the conditions are fair. As such, they do not want to sell their entire holding of the security.
Secondly, the client may choose to sell a portion of the investment to buy additional blocks of the same security at the lower price. Again this bold move is dependent on the client's investment outlook. If one is investing for the long term and believes the investment is a strong, solid one that will recoup, then making this "move" will help to reduce the average price of the overall holdings on the security.
John Brown purchased USD$50,000 of Security X @ a price of $100.00
The price has fallen to USD$78 and he decides to sell 25,000 at the current price.
Mr Brown then buys USD$25,000 of Security X @ a price of $80.
Mr Brown's total holding stands @ USD$50,000 of Security X at an average price of $90 = [100+80/2] (instead of $100)
Microeconomic or "micro" factors are concerned with the factors that affect individual economic choices and how the choices are coordinated by market. If micro factors are the main cause of a decline in a security's value the investor may choose to either sell that investment or invest in another sector of the market. The course of action is dependent on the origin of the decline in performance, is it a recent negative news item that has no significant bearing on the strength of the company? Or is it a fundamental change that makes the business model of the company obsolete?
However, microeconomic changes also refer to changes in the investor's personal preferences. Perhaps an investor is no longer comfortable or satisfied with the broker through which he/she originally bought the asset. This is remedied easily by transferring the security to another broker with whom you are more comfortable. Also, an investor may change his risk profile, objectives and preferences, therefore resulting in his desire to sell the security.
* Mr John Brown bought US$50,000 of a bond issued by a technology company five years ago. Mr Brown has recently started a new family and has a more conservative risk profile. He wants to sell his technology holdings and invest in a safer industry.
* Mr Brown bought USD$50,000 of Security X through Broker XL Ltd. Security X recently reduced its profit forecasts for the next financial quarter. This caused the price of the security to plummet beyond Mr Brown's loss limit price. Mr Brown is now uncomfortable holding the security so he may choose to sell Security X.
* Mr Brown has USD$50,000 of Security X through Broker XL Ltd. However, Broker XL has recently been bought by an international firm and is no longer providing good advice. Mr Brown may choose to simply have the security transferred to another institution.
Investors are not able to control the market but we can control how we respond to the market. Do not ignore invesment or deny its lack of performance. Seek competent professional advice from someone who has your best interest at heart.
Dian Blackwood is a personal financial planner with Sterling Asset Management Ltd. Sterling provides medium to long term financial advice and instruments in US and other world market currencies to the corporate, individual and institutional investor.
Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: firstname.lastname@example.org