Economic tug-of-war will cause sideways drift.
The many moving parts of the world economy are in an epic tug-of-war.
Because of concern over job security, Canadian households don’t know whether to spend more, save or pay-down debt.
Corporations are staying afloat by managing costs; typically that means people and inventory. The decision to re-hire or restart manufacturing depends on demand that might be either temporary or sustainable.
Governments are spending trillions to get the wheels of commerce turning again but don’t know when to stop. Too much spending causes inflation. While not enough risks stifling economic growth.
The various parts of the economy pulling in different directions, gets reflected in stock, bond and real estate markets. Because this recession is worse than average, the tug-of-wars are bigger this time. This can cause the economy and the markets to start and stop again and again. Stand back and investors might see a sideways drift. Not a straight line sideways but with a lot of up down volatility. Rather range-bound with a restart at the floor with a stop at the ceiling. Like 1966 to 1982. Or like 1998 to 2008.
While, consumers, businesses and governments are looking for the right balance, investors look for direction.
Ironically, a sideways drift is perfect for three very powerful investment tools.
Dollar-cost-averaging is an effective strategy for all markets but it is especially well suited to volatile markets. Rather than trying to decide when to buy, simply buy on a regular basis. Like weekly or monthly. A bit now. A bit later. Investors buy more when prices are down and less when prices are higher. Over time, costs are averaged which tends to flatten out market volatility. There is no second-guessing, no emotion and no attempt to time the market. It’s like automatic payroll deduction for your investments.
Rebalancing moves money from an asset class that has done well and is now at risk of being overvalued and then reinvests into an asset class that has not done well and may now be undervalued. Sell high. Buy low. When a portfolio drifts away from the investors intended target allocation between stocks, bond and real estate, the risk characteristics of the portfolio change and it may not deliver the desired return results. Rebalancing on a regular basis, ensures that when market extremes are reached they are sold at a high and bought at a low ‘before’ they correct back to longer term averages. In this way, rebalancing smooths the highs and lows while contributing to performance.
Dividend reinvestment is the automatic compounding of dividends for free. Dividends (or any distribution) get reinvested into more shares each time they are paid. So your 100 shares become 103, then 108 and so on. Over time, the number of shares owned grows (as dividends themselves tend to do). Reinvestment is true compounding and a better alternative than having idle cash sit in your account.
Originally published in the Business Fraser Valley news, October 2009.
Doug Cronk CFA, is Manager Investments for a Canadian Pension Fund.