Wednesday, October 15, 2008

Keep the faith!

These are indeed turbulent times. The Stockholm Stock Exchange dropped 21% last week! I looked at my portfoilio and could conclude it had dropped 51% during the last one year period. Living in Frankfurt, with many friends in the financial sector, I hear a lot of negativity. But that is the completely wrong position to take!

Think positive! This is just great, actually. Money has been too cheap for too long (or rather risk has been too cheap, almost neglected completely). What we see now is just a market realizing it was wrong and need to adjust. Lehman Brothers went under because they had too thin margins. They borrowed 95% to their investments in the end. Now this is just awesome as long as times are good. If the investment gains 10% the return on capital will be 200%! Those numbers would make any banker have wet dreams, so no wonder they got greedy. But at the same time, a decrease of value with only 5% would eat up all you capital. Not good in normal times. So those now suffering killed themselves, don't feel sorry for them. But we must make sure the rules are changed, so such idiotic investment schemes won't hit average Joe again. (There are rules saying banks have to have that big margins, but those were elegantly circumvented by using very creative financial papers' constructions.)

The problems we have see now regarding the lack of short term loans is surely a problem, but why does the problem exist in the first place? Because there is no trust. Bankers don't trust each other, because when it comes down to it they are all egoistic greedy people and they now it, so of course you don't lend any money! But seriously, the margins on these loans are slim and with the situation being what it is it's no wonder anybody would rather keep the money under his pillow rather than lending it o somebody else. Normally that is not a risk, but with the slim margins even the slightest risk is too big of a risk. Again, this is where governments have to step in. Because as we can see now, in bad times the only thing trusted are the governments and their central banks. Even the Financial Times publish coloumns about the good of socialism! I find that very comforting indeed.

But what should then the average Joe do, when he sees his investments crash? Nothing. Just keep on buying funds, every month, no matter what happens. After many years of listening to the "experts" what I learned was that it's luck and luck only that makes a good stock deal. In fact, nobody can time to buy at the bottom and sell at the top. So, don't even try. Instead, put away as much as you can spare every month, through good times and bad.

Let me give a short example to explain: Let's say we start saving 100 euro a month in January. Unfortunately the market then drops 20% a month for two months and we might feel a bit bad. But then the market turns and increase by 5% a month for the rest of the year. This means that our funds are back on the January level in November (perfect for the Christmas shopping). This scenario is a bit too fast for what we have seen this fall, but look at the beauty of it! In March we will have lost 40% of our January money, but on the other hand every month we get more funds for the same 100 euro we invest. Look:

Month SharesValue
January 100 100
February 225 180
March 392 235
April 546 355
May 688 482
June 822 616
July 947 757
August 1064 905
September 1175 1058
October 1281 1217
November 1381 1381
December 1476 1550

Note how we are on plus in June already! And by Christmas, when the market is up 5%, we have a 29% win!

Of course this effect is smaller the more money we have invested already in January. In fact, if we started these monthly payments 2 years ago and have 2400 euro at the beginning of the year, we'd have to wait until October to be on breakeven! However, money that you invest in stocks and bonds must be money you don't need for few years at least. The main thing is to make a difference between the money being used to build a fortune at money already being a fortune. With the "building money" you should play tough and keep on investing, but with a larger fortune you should apply totally different strategies. I'm not there yet, so I'll be back on that subject! ;)

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