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Guest Post by Paul Lindholm – How to invest through unforeseeable times?
Paul is the founder of Forehand Financial and has been educating financial literacy. His two passions are finance and tennis. He blogs, interviews, and coaches clients to help optimize their personal financial situations. He enjoys studying macro and micro economic trends and is helping individuals navigate through any time.
I have always found it fascinating how certain people can turn one dollar into ten, and how others can turn ten dollars into one. I have always wanted to be the former because money can provide us with almost all our material desires.
Throughout this article, I am going to discuss how to invest from a principle standpoint. I also go over several things to be aware of with this dramatically changing economy and investing environment.
I bring up many points as a worst-case scenario, while also providing options to remain resilient and come out stronger during this current crisis.
Stay Out Of The Current Media Emotional Rollercoasters
The number one thing I see amongst investors right now is they see a drop and they think I must get in now, or they are going to miss an opportunity. Additionally, there are so many headliners from most media outlets on what is a good buy and what is not.
Usually, by the time this information makes its way to you, it is already built into the investment price.
Sometimes the best trade is no trade, we need to be patient. If you do not see anything that looks appealing from a fundamental or technical perspective, stay in cash. At least until you are confident, well informed, and are ready to deploy.
Try Not To Catch Falling Knives
The entire travel, hospitality, and a large section of the service industry are getting steamrolled so far this year and the worst may not yet be over. As we see many places around the country reopening, we see many sectors starting to steadily increase.
Many stocks right now have already dropped in value dramatically. Just because the price is normally at $50-60 a share, and now it is $8.00 a share does not necessarily mean it is a bargain.
If things do get worse, the government will not be able to bail out every company.
Look at the 2008 worst-case scenario. That $8.00 a share that was valued at $50-60 pre-pandemic, has the potential to be valued at $0.00 a share.
These are the risks of investing. You should consider if the company has a strong balance sheet to continue losses (until a vaccine is found). And always invest per your risk tolerance.
Lean Into Industries That Will Remain Resilient
A few companies will have a better time weathering the storms ahead. While many of them have already had a decent run-up so far, they won’t be as impacted. They will be steady good investments in the coming years as demand for these won’t drop off.
For example, entertainment, telecommunication services, delivery services, and consumer staples.
Healthcare stocks also have been performing relatively well to the broader market this year. No matter what happens, it is essential to have these services. In other words, they might continue to fare well through the end of the year.
Always assess how companies have performed thus far before investing in them. Look for steady upward trends.
Look For Economic and Monetary Policies Changes
Massive quantitative easing leads to dramatically increased inflation and can have profoundly bad implications for the economy.
Negative interest rates encourage borrowers but discourage creditors. Bank depositors pay the bank money to hold their cash rather than another way around (current January 2021 Futures).
These have implications we have never seen before in the United States. That is why it is important to understand how these economic situations will impact your investments.
Situations like this have cascading effects on most asset classes across the market. For example, investors might move to real assets such as precious metals (gold, silver). These assets already had huge runups so far this year alone.
Furthermore, the FED is buying ETF (Exchange Traded Funds). It props up and drives asset prices higher (even if the fundamentals of these respective assets haven’t changed).
Also consider, when the FED’s lower interest rates. Bank’s interest rates are impacted heavily which can drive down the valuations and earnings for financial institutions.
Already this year, earnings for many banks are down, and given the FED has exhausted most monetary measures, I cannot see interest rates increasingly anytime soon (before the election) at minimum.
Be Aware Of Stocks That Have Already Made Huge Runups
Many stocks have risen dramatically in price since this pandemic has occurred. Their sales increased dramatically due to many of the quarantine related activities.
What happens when a vaccine is found? Will these stocks still be rising (at the rate) in which people were homebound? Likely not, and when businesses reopen people will not want to spend any more time indoors than they already have.
People will want to interact with others, bike outside, and make up for the lost time they had when quarantined.
Knowing the investment philosophy buy low sell high, would you want to enter these positions with an unknowing upside?
Always Diversify Your Investments
Now more than ever, you do not want to be overexposed to any one sector (Real Estate, Financials, Industrials, etc.).
Diversification is one of the most important things when it comes to learning how to invest. There are certain aspects of investing that are always beyond our scope of control.
For example, travel may be battered, but if you have a balanced portfolio with precious metals, consumer staples, and healthcare, you will not have felt like much of the burn this year.
When you diversify, you hedge yourself to the point where if something beyond your control happens, it limits your downside.
Be Flexible And Nimble With Your Trades
What may seem like a good trade last month, may not be so much this month. For example, looking at Royal Dutch Shell, they had a strong healthy dividend and it was cut almost completely.
Do not be afraid to get out of an investment if the only reason you’re in it is for the juicy dividend. It is not because an investment is great one day that you shouldn’t reconsider your position regularly.
Do not be afraid to cut losers, especially if you do not see any further advancement. Often, as investors, we face something called the notorious sunken cost fallacy.
My friend recently tried to spend close to an hour trying to find a parking spot down at the beach. Since he has already invested so much time trying to find the parking spot, he will continue to try and find a spot no matter if it takes another thirty minutes to an hour.
The same thing happens with investing. Sometimes we may lose 20, 30, or even 40% on investment. Often, we will say I have already lost this much, I am going to wait for it to go back…
Sometimes it never does, and it will fall another 20-40%. Therefore, it is important to always have an exit strategy with your investments. A great strategy is to set up a stop loss on your investments to avoid a more drastic loss.
How To Invest In Resilient Companies
Look for quality in these uncertain times. Highly leveraged companies may pay a handsome dividend when times are great. However, they might not be able to service this when the creditors come knocking.
To assess the true value of a good investment, look for the following:
- Current ratios above 1
- Prospective earnings growth
- Strong leadership team
- Adaptive to changing markets
- Strong cash flow
- A Lot of cash on the balance sheet
- Healthy enterprise value
While playing into trends and speculating can be exciting for short term prospects, and high percentage gains, over the long term it’s risky. Sometimes it can be no better than throwing your money on black at the roulette table in the casino.
From my experience, prices tend to reflect the underlying value of the security, and over time the market is efficient.
Overall knowing how to invest is something that I believe everyone should take part in steadily throughout their lives. Whether you start with an account of $100 like my dad provided me, have a large trust, or are somewhere in-between, it is never too late to begin investing.
The best time to start is when you are younger, or as soon as possible. The best thing to do is to dollar cost average steadily over your investing life.
Never react emotionally or get attached to certain companies in which you have a bias. And equally, never think the market acts logically and in lockstep with the economy.
It is complicated, it is difficult, but this is precisely what makes investing so rewarding when one does it right.