Big investment mistakes in a global recession

AGAINST a highly challenging global economic outlook, a global recession looks imminent. The Malaysian economy is expected to see a contraction of -2% at its worst and growth of 0.5% at its best in 2020, compared with 4.3% in 2019.

Meanwhile, the International Monetary Fund (IMF) anticipates the world will ‘very likely’ experience one of the worst recessions since the Great Depression in the 1930s. A partial recovery can be expected in 2021, but subject to an improvement in the Covid-19 health crisis.

What is a global recession, and for that matter, why is the impact from this one occurrence more profound, perhaps even more prolonged than ever?

Firstly, the scale in which Covid-19 has impacted the economies. The countries in which the virus has infiltrated has caused nations to go into lockdowns in epic proportions.

This, in turn, spurred the unemployment rate, diminished consumer sentiments and purchasing power, stifled business growth and sent financial markets into a tailspin.

Compared to the 1997 Asian Financial Crisis which had gripped much of South-east Asia, the road to recovery from the 2020 “Great Lockdown” would be a long and arduous one. The GDP per capita is projected to shrink for over 170 countries.

So, we are not looking at a recession anymore – what we have, is a perfect storm for a global recession.

When economies head toward a global recession, personal incomes would drop, while some may even hit zero. Businesses will be hit hard, in fact, some businesses may not even survive the long drawn out drought. Meanwhile, investment asset prices would be wrecked with volatility.

The Dow Jones on March 11, fell by nearly 10%, from 23,553 to 21,200, one of the sixthworst percentage drop in history. On March 13, it rebounded by 9.4% to 23,185 points. Talk about a comeback! – that‘s how volatile the investment market can be in a global recession.

So what does this mean for investors? A global recession presents great investment opportunities – good bargains are everywhere. It fact, some of the best buying opportunities take place now. But, there is the risk of losing some, if not all your hardearned money.

The investment environment is so challenging that even great investors like Warren Buffett couldn’t resist buying up shares of what was perceived to be a great bargain with Delta Air Lines. He was later forced to dispose of shares from the battered airline at a huge loss when he realised that it was a mistake. So, what are the mistakes that are especially costly to make, during a global recession?

I have eight fatal investment mistakes to share.

>Maximising investment return

It is only human nature to chase for maximum returns. However, maximising the return without paying any attention to any risks, is risky business.

For example, investors may be attracted by the massive upside potential with small cap shares that have dropped from RM1.00 to RM0.10. Even if the share was to move from RM0.10 to RM0.30, there is already a few hundred per cent gain.

Just because a stock appears cheap, it does not necessarily make it a good investment. If you are not able to detect and manage the associated risks, you may unknowingly invest in a high-risk investment. You may even risk losing your hard-earned money when the small cap stock drops even further, or worst gets delisted from the stock exchange.

> Having too little or no cash reserves for an emergency

Cash reserves are good to have, especially when you need access to it during an unexpected event such as in a loss of job situation.

Some investors may invest all their monies without providing for cash reserves. In that case, they would deprive themselves of any investment holding power.

If you have holding power you can afford to hold your investments and ride out any crisis without being forced to sell them for liquidity. But if you don’t, be prepared for the possibility of losing all your investments, or selling them at a loss.

An example I can think of is property. In a recession, opportunities to buy good properties at an attractive price, in great locations, are everywhere.

Good investment or not, the bank will repossess your property if you do not have enough cash reserves to service the monthly loan repayments. In the end, that piece of property that you had owned would end up in the hands of investors that has good holding power.

Some people may ask, how much cash reserves are enough? How much cash reserves to set aside, depend on your own unique financial situation.

Ultimately those who have holding power always wins.

> No diversification across different asset classes and countries.

Warren Buffett once said that diversification is a “protection against ignorance,” meaning that when it comes to investing, there’s no way to know everything about an investment and no way to predict the future.

The problem is that many investors have a tendency to chase performance by aggressively investing in a single class of investment: stocks when the equity markets are rallying, and bonds or cash during a market decline.

Take for example, an investor may invest only in a Malaysia equity unit trust fund. Even though he has diversified the investments into five Malaysia equity funds from five different unit trust companies, the chances of the investments rebounding, are limited by its asset class, Malaysia equity.

This lack of diversification can play havoc with a portfolio during times of market turbulence because you are limiting the rebound potential of your investments by its asset class.

When other markets start to rebound and your asset doesn’t, you would be forced to hold on to your investment for a longer period, three to five years.

During this time, whatever emergency cash that you have, may run out. In that case, you may be forced to let go of your investment at a loss. That would defeat the whole purpose of capturing great bargains during a global recession.

> Over concentration in one investment Investing a lot of money, if not all of it, into one single stock, or one direct bond or even one piece of property is a huge mistake.

Take for example, direct bonds. Some corporate bonds may appear to be very attractive, especially after a market correction. The yield may rise from 5% to 10%. Compared with 3% interest from fixed deposit, direct bonds seemed very attractive.

You may be led under false belief to invest all your money in bonds, on the promise of a high yield. After all, bonds are one of the safest investment vehicles, and least risky next to fixed deposits.

However, in a global recession where the business environment is extremely challenging, there’s a risk that the company, may go bust.

Therefore, all your money placed in the bond would also go up in smoke. Adolf Merckle, the 94th richest man in the world then, was one of the financial casualty who bet all his wealth on one single stock, ie, Volkswagen.

A global recession presents great investment opportunities – good bargains are everywhere. It fact, some of the best buying opportunities take place now. But, there is the risk of losing some, if not all your hard-earned money.

Unfortunately, the share moved in another direction, Meckle lost a lot of money and took his life. That is how bad it could be if you focus all your money in one single investment that may seem promising in the beginning. > Investing with margin financing Margin financing is the act of borrowing funds from a broker to gain more capital to invest in shares, and by extension, the potential for more profits.

It is a very risky move, one which I advise against using as it may lead you to over-estimate on your investment capital, thus causing you to invest in more securities that you can buy with your existing available cash.

If the investment goes well, you earn lucratively. If the investment performs poorly, not only would you suffer from investment losses, but you may even get stuck with a huge loan to repay.

Benjamin Graham was Warren Buffett’s mentor. He ended up bankrupt in a margin call during the Great Depression in the 1930s.

> Too many loans (note to property investors)

Taking too many loans to invest during a global recession would cause undue cashflow problem and financial stress, and complicate your financial situation if you are laid off or have your income cut for some reason.

For example, some investors may be tempted to take up a mortgage loan or personal loan in order to finance and acquire some cheap properties during a recession.

Truth to be told, how else would you ever get an opportunity to purchase a great piece of investment property for a fraction of its price, but during a recession?

But therein lies the danger, and the risks, for that matter. The temptation to buy more than one could possibly afford and causing your debt to asset ratio to tip in an unhealthy direction, more than 50%.

In short, taking on a new debt in a recessionary environment is risky and should be approached with caution. In the worst-case scenario, it could even contribute to bankruptcy.

> Not monitoring your investment performance closely enough

On any given day, not closely monitoring your investment performance is manageable and would not cause any ‘life or death’ situation. But not in a global recession.

The “coronavirus crash” has been one of the swiftest peak-to-trough market declines ever, with nearly all asset classes experiencing losses over a few weeks. For example, between Feb 21 and March 20, the Dow Jones index dropped 9,818 points (33.8%) in one month.

If you are not there to babysit, I mean monitor, your investments on a daily basis, and be ready to cut underperforming investments, you would be in for a rude awakening.

> Holding on to underperforming investment

Holding on to underperforming investments, especially during a recession, is very dangerous. But the fact is, there are many investors who continue to do so, hoping that the price will rebound and go up again.

There are investors who have lost money in share, but refuse to make any adjustments when the price drops. In their mind, they console themselves that the loss is only on paper.

But the truth is, in a global recession, whatever investment that shows weaknesses, compared to its peer, maybe the very reason why it would continue to perform badly. Therefore, these investments will continue to fall in prices and worst, vanish completely.

In this situation, getting rid of such investments (underperforming compared to their peer) to raise cash and reinvesting the money into other resilient investments, is key.

Reading the newspaper headlines during a recession can convince you the sky is falling, but in actual fact, this could be one of the most exciting time for investors as there are many great bargains for the taking.

To capture the great bargains successfully and with peace of mind, you must put in place a robust plan to prevent you from making any costly and unnecessary mistakes which may be fatal to your hard-earned wealth.

Yap Ming Hui (ymh@whitman.com.my ) is thrilled that his mission to empower every Malaysian with a roadmap to financial freedom has finally come to fruition with the release of a free DIY roadmap to financial freedom tool on the iwealth mobile app. The views expressed here are the writer’s own.