THE SOCRATES COLUMN
 
True wisdom comes to each of us when we realize how little we understand about life, ourselves, and the world around us.

HOW TO DEAL WITH UNCERTAINTY

"Reports that say that something hasn't happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns -- the ones we don't know we don't know. And if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones."

Donald Rumsfeld, former US Secretary of State for Defence

The above comment was widely reported when made during the Iraqi War, but its relevance is particularly striking today. With collapsing oil prices, the unpegging of the Swiss Franc from the Euro, political issues in Europe and Asia, strange weather phenomena and the rise of militant Islam, we sometimes may be forgiven for retreating from the markets and letting these forces play out. That would be a mistake.

In truth, most of Rumsfeld's anguish centred round those things which are 'known unknowns'; we are aware that the global financial system in under threat, but don't know how this will play itself out and over what time scale. We also know that terrorism is a real and present threat, but don't know where it will next manifest itself. We are aware that climate change is producing extreme weather patterns, often leading to economic disruption and loss of life, but again: we do not know when or where. Finally, no-one appears to be sure what President Putin is up to?

As investors there are a number of things that we can do to at least blunt the impact of this uncertainty. I would suggest the following:

  1. Accept the fact that the world is a dangerous, yet exciting place. Risk has its rewards but even holding too much cash has its own risks, especially during inflationary times.
  2. Don't follow the crowd. One certain way of losing money is to buy at the top and sell during any sell- off.
  3. Ignore the noise, and focus on the fundamentals. In this era of 24/7 news coverage, journalists need to sell their stories, and bad news tends to make better copy.
  4. Continuously assess your risk profile. Many investors underestimate the impact on their wellbeing as well as their wealth of a market crash. Are you insulated from a currency crash?
  5. Stress test your investments. Could you survive a market correction of 40 to 50%? These events do occur as part of a natural cycle. Remember the crash of 2008 and the subsequent rally.
  6. In the event of a market upturn, can you view this as a phase in markets, and not an excuse to cash in your chips?
  7. Keep your asset allocation intact through the cycles and in line with your longer term objectives. Let winners run, but sell your losers when their markets turn down. Diversify your investments within each asset class. Choose the best long term performing asset managers. Don't have all your assets in one currency.
  8. Don't forget to keep some liquidity within your investments to protect against bear markets: it is always important to be able to access cash if needed, and - if possible - without having to sell shares.
  9. Drip feed your investments, and enjoy the advantages of cost averaging.

Even though there are uncertainties out there, and there will continue to be cycles and volatility, there is a long-term trend with the stock market. If you ever want to see the impact of staying in the market over the longer term, look at the long-term trend of the S&P500 index since the beginning of 1970 from whence the index has increased by no less than 2,145%! Even over the last 5 years, the index has increased by 79%. What must seem like catastrophic and gut-wrenching gyrations, large rises and falls in the market are evened out over time and carefully selected equities should continue to comfortably outperform other asset classes by a significant margin.

Regarding the comment by Rumsfeld, linguist Geoffrey Pullum stated the quotation was "completely straightforward" and "impeccable, syntactically, semantically, logically, and rhetorically"

Now you know!!

Posted: January 2015

 
 
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