november, 2008
The Second Opinion: Decisions, Decisions...
Dismal Economic Forecasts Raise Tough Questions
by Carlo Palazzo, CIM
The global financial crisis is no longer simply financial—it is spreading to the broader economy. Evidence of this can be seen daily in business magazines, websites, and newspapers.
The most recent dismal forecast comes from Global Insight, a forecasting firm that has recently predicted that the Canadian economy will shrink in the fourth quarter of 2008 and the first quarter of 2009, meeting the two-quarters-of-negative-growth definition of a recession. They also predict that the Canadian economy will shed 100,000 jobs by this time next year. And Global Insight is not the only firm making such forecasts. Bank of Nova Scotia, Merrill Lynch, and TD Bank have made similar predictions. Even the Bank of Canada is forecasting negative growth for the fourth quarter of 2008 (though they predict a speedy recovery in the first quarter of 2009).
These grim forecasts are not isolated to Canada. The Organization for Economic Co-Operation and Development (OECD), a Paris-based think-tank, has predicted that, as a whole, the economies of it’s 30 member countries will face negative growth (i.e. recession) in 2009. Furthermore, they predict the unemployment rate in these 30 countries will increase in 2009 and 2010. What’s worse is that they are calling it the start of “a protracted downturn”, implying things may be bad for at least a few years. Furthermore, they have based these recession forecasts on “an assumption that the extreme financial stress since mid-September is short-lived”. If that assumption is false and the financial crisis lasts longer than expected, one would assume that the actual results would be worst than the OECD’s forecast.
The sheer number of negative forecasts makes it quite clear that we are entering tough economic times. And with tough economic times comes tough decisions. What asset mix will best protect my portfolio? Can I afford my planned vacation, or should I settle for a more frugal vacation close to home? Is retiring right now really the right decision, or should I work for a few years longer than planned?
Luckily, many people reading this will have a financial plan in place and therefore know what saving, spending, and rate of return targets they must make. Those who do not have a financial plan in place are walking through the wilderness without a map or compass.
In light of the tough economic times and related tough decisions that face our subscribers, this issue of The Second Opinion will focus on Warren MacKenzie’s tip #92: Don’t Assume You Can Delay Making An Investment Decision.
Tip #92: Don’t assume you can delay making an investment decision
by Warren MacKenzie
Why this is important: Unless you are in a well-diversified portfolio, the market can be dangerous and unforgiving. If you think you can stop the market forces because you want to make your decision at a more convenient time, you are increasing your odds of losing money.
Investors sometimes feel uncertain about which way to proceed and think they can postpone making a decision. With investing, however, it is impossible to delay a decision: a decision to delay is in fact a decision to stick with the status quo. Doing nothing may be the right decision if you are out of the market and the market is going down, but it may be the wrong decision if you are in the market and a severe market decline is on the horizon.
For example, a few years ago when Nortel was trading at $120, some investors ignored their financial advisor’s advice to sell because they wanted to wait until more facts became available. That “do nothing” decision cost them dearly as Nortel fell to under $4 per share. These investors intended to make a decision but were not quite ready. Deciding to do nothing was in effect a decision to hold on to a vastly overvalued stock.
The three possible investment decisions are to buy, sell, or hold. Holding is less obviously a decision but it is a decision nevertheless — a decision not to change the asset mix. If you are in the right asset mix, this may be a wise decision. But if your asset mix should be changed, then doing nothing may be a big mistake.
Investors usually put their capital in three asset classes: stocks, bonds, and cash. Cash, as an asset class, occasionally turns out to be the best performing. If an investor has cash in the bank, this is a decision to invest in cash as opposed to stocks, bonds, real estate, or any other asset class. If the other asset classes fall in value, the decision to stay in cash will have been the best. On the other hand, if the investment that was being considered rises in value, and now more cash is required to purchase the same investments, then this was not the best decision. The decision to do nothing can have just as big an impact on your financial future as the decision to buy or sell. Do not be misled into thinking that you can avoid making investment decisions. You can delay the decision to buy and you can delay the decision to sell but this only means that you are making the decision to hold.
Bottom line: Doing nothing is an investment decision. It is a decision not to change your asset allocation. It may be the right decision or it may be the wrong decision, but investors should not deceive themselves into thinking that they can avoid or delay making investment decisions.
What you can do now: Take a look at the way you make investment decisions. Ask yourself if you have done all you can to get a financial plan, to understand your investment strategy, and to take control of your finances. Spend a few moments imagining how the decision to do nothing, to leave things as they are, may hurt your retirement plans.
