People often find themselves suddenly coming into a chunk of unexpected money and they need to decide the best way to invest it. As we are in a situation where the broad markets continue to be highly overvalued, the downside risks of just throwing the money into the market are very high. One way to avoid getting caught at the peak before a crash is to put the money into a discount brokerage account and create a “wish list” portfolio that you would want if the individual stocks were trading at the right valuation. The key to this strategy is that you patiently wait with the money in cash until each company hits your desired price before purchasing it.
Many of the top investors of the world follow a similar strategy. Rather than wait for the markets to be crashing, and then trying to figure out when you are close to the bottom, and only then figuring out which companies you want, it is much better to have a wish list put together ahead of time. Then you do not need to try and pick the bottom of the broad market move at all. You just need to know which prices you have determined are fair to buy the companies you want to hold long term. When the stock trades down to that price, you have a pre-set alert inform you that it is time to make the purchase.
A good rule of thumb is to try and buy companies trading at price to earnings ratios of 10 or below. If you want a portfolio of say 20 companies, you may in fact need to make a wish list of about 40 (some may unfortunately not dip down to your valuation target even in a severe crisis). When the market begins a serious retracement, you may find that a few of your desired targets dip into buy range without the broad markets even crashing. In the event of a full on crash you may find that within the space of a few days they all tend to end up as value buys at about the same time. Thus it also makes sense to make a priority list in the event this happens.
The great thing about this strategy is that if you pick solid companies and they survive, you will almost certainly double your money at the peak of the following bull market, even if that may be some time away. If the broad markets peak at over a price to earnings ratio of at least 20, which they always do at the end of a cyclical bull market, most likely your stock holdings will all be valued similarly. This assumes earnings can even stay flat over the period, whereas in reality they could grow if you have picked stocks where the companies are still in the growth phase of the business life cycle. A few may see declining revenues if you have not picked good companies, hence the more diversified you can be the better your odds of having the majority continuing to grow.
You will never pick the exact bottom of a crashing market in the same way you can never pick the exact top of a bull market. It’s a fool’s game to even try, but by following the long time horizon cycles and using valuation as a decision making criteria you can assure that you get a safe chunk out of the middle of the overall range. Your individuals stock holdings will almost always immediately drop after your purchase when you follow this strategy, and your account value could stay negative for a few years even. This is because of the very nature of buying in the midst of a falling market, but don’t worry as it won’t last. Bear markets are usually fast and furious, and the following bull market will always bring the markets back to their previous highs if not higher.
David Mayes MBA provides wealth management services to expatriates throughout Southeast Asia, focusing on UK pension transfers. He can be reached at david.m@faramond.com. Faramond UK is regulated by the FCA and provides advice on taxation and pensions.
