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Strategy
No. 2:
Understand the Investment Clock
Have you noticed how the
beginning investor will often wait until the market
moves before buying shares or property? The reality is
that by the time the beginning investor is aware that
the market has moved, the experienced investors have
already moved the market to the next level. So, how do
they do this? Well, the experienced investors tend to
buy before the market starts to inflate and prices start
to go up. They do this by understanding the investment
clock, which is based on the well-known phenomenon that
business cycles occur, on average, every seven to nine
years.
Many investors have
trouble coming to grips with the probability that events
can turn out in a cyclical fashion. However, history
indicates that the probability is very high indeed. The
sooner you, as an investor, live through an investment
cycle, and see the recurring nature of booms and busts,
the sooner you will become a better investor and
understand the importance of timing of your investment
decisions.
Understanding the
investment clock is a useful tool for guiding you along
the journey to financial independence. It helps you know
when to invest and the best performing assets at a given
point in time.
The investment clock is
not a really good tool for predicting the timing of
economic trends with great accuracy. Its real value lies
in its ability to depict the cyclical relationship
between the share, property and fixed interest markets
and the order in which they occur.
The clock tells you the
most appropriate investment medium, considering the
prevailing economic indicators such as interest rates,
commodity prices and inflation. It shows that the share
cycle is followed by the real estate and then the fixed
interest cycles. The investment clock has proved
accurate in reflecting the market forces that drive the
various investment cycles. And the order in which they
occur.
Looking at the clock,
twelve o'clock is the boom and a rapid increase in the
demand for real estate results in property prices
rising. Often property prices rise by 20% per annum
during these boom years.
As property purchases
are primarily funded by borrowing, the increased demand
for funds causes the cost of funds, that is interest
rates, to rise. As interest rates rise, companies find
it harder to make profits, and this together with the
fact that the booming property market and fixed interest
investments seem more attractive, causes share prices to
fall or at least stagnate. As property prices tend to
boom at these times and because interest rates rise, the
rapid growth of the property market cannot be sustained
for more than a few years. Property prices stagnate and
even fall.
At about 3 o'clock in
the investment clock, the share market is usually doing
little and offers few prospects for investors and
interest rates are too high to make borrowing for
property an attractive option. This is the fixed
interest or cash part of the cycle when cashed up
investors can take advantage of the high interest rates
on offer to lenders by way of bonds, debentures and cash
deposits in financial institutions.
Other investors just try
and battle on paying more interest on their borrowed
funds.
High interest rates slow
the economy and lead us into the recession.
This brings us down to
six o’clock; in the depths of a recession and as
mentioned Australia has a recession of varying magnitude
every seven to nine years. Now investors are either too
scared, or cannot afford to borrow money and in time
interest rates slowly start falling. Also during these
times companies are forced to become leaner and increase
productivity. These measures and the slowly improving
economy translate into increased company profits and
this gradually stimulates share prices to recover.
We are now at about 7
o'clock. At this point in the cycle most people have
left the market having sold their shares as a result of
the economic downturn and retreated to cash, fixed
interest or even property. Interest rates range down to
historically low levels and eventually the point is
reached where long term investors see value in the
market and start to accumulate the better performing
stocks. The seeds of the next recovery are sown and
eventually equity and commodity prises will rise.
Understanding the cycle
and the cyclical relationship between the share,
property and fixed interest markets is critical if you
want to maximise the return on your investment dollar,
with the minimum of risk.
You may well ask - why
do economic cycles occur in the first place? Why doesn't
our market driven economy find a nice equilibrium? The
simple answer is that the world economy is a collection
of many nations each at their own individual point of
the economic clock. And each nation is made up of
millions of people each making their own financial
decisions as a reaction to, or in the expectation of,
other people’s decisions. The sheer momentum of all
these economies means that they always over swing the
mark, resulting in cyclical economic movements.
Next:
Understand the Psychology of the Market
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