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How to protect your wealth when the JSE is falling

8 October 2014 1:33 PM

How to protect your wealth should the JSE start to weaken...

(Click here for more personal finance articles such as this one.)

The Johannesburg Stock Exchange has enjoyed stellar returns for more than five years; it won’t go on forever. Is it wise for long-term, small investors to cut their losses and flee for “safety” if (read "when") the market turns sour? Almost certainly not! Let us explain…

Turning “paper losses” into actual ones

“Sell high, buy low” is the cornerstone of profitable trading in any goods imaginable. You cannot get rich by doing the opposite, yet all over South Africa small investors will, as in the past, start doing exactly this when the bear market (i.e. when share prices are falling) makes its return.

Selling when the market is down turns a “paper loss” into an actual one.

A “paper loss” happens when the value of the shares (or any other asset) you own falls to below what you paid for them. However, until you sell your shares, the loss has only been taken “on paper”. Only when you sell do you “realise” the loss. In other words, if you sell you suffer a real, permanent loss while retaining your shares entails keeping the loss “on paper” - it isn’t permanent and the share price can still recover.

An example of a “paper loss”:

Thandi moves to Cape Town and buys a small studio flat in the swanky city centre for R1-million. The property market goes through a slump and, three years later, it’s only worth R800 000. Thandi still owns the exact same property, she still lives there and nothing much has changed.

Thandi suffered a “paper loss”. If, however, she sold at R800 000 she would have made real the loss of R200 000 and she would be without her flat.

Stay calm! Don’t panic!

If you're making investments for the long-term (longer than, at least, five years) you should not get spooked by short-term market volatility. If you have a well-diversified portfolio, you'll do well to stay the course; only change your strategy if your own circumstances or goals change.

While the stock market is very volatile over the short- to medium-term, its trajectory over the long-term has always been up. In fact, the stock market has never lost value over any ten year period in its entire history. Over longer terms there is close to no risk that a well-diversified portfolio of stocks will lose any value. It is, obviously, possible to suffer short term losses but for those taking the long view these losses are completely irrelevant.

Over the long-term no other asset class has ever performed better than stocks and those who ride out the inevitable bear markets (i.e. falling markets) are always rewarded for being patient and staying cool under pressure.

It's normal to panic, but if you act on that fear, by selling shares you bought as long-term investments, you will damage your wealth in a way that no market crash, no matter how prolonged or severe, can ever do.

Stock market lows are a great time to invest even more. Believe it or not, a great way to get rich could be to do exactly the opposite of what many small investors will soon feel compelled to do.

Remember, the stock market will fall again and again and again and again. If you freak out and sell every time it does, it won’t take long before you’ll be reading about the recovery while having nothing left.

(Click here for more personal finance articles such as this one.)

Kabous le Roux is a financial journalist and digital content producer at Primedia Broadcasting. He cut his teeth at where he was the Personal Finance, Property and Business Editor. Kabous has a passion for making complex ideas broadly accessible.

8 October 2014 1:33 PM

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