What a rotten day for Australian stocks.
The Reserve Bank of Australia (RBA) wanted to boost asset prices.
It wanted the Aussie dollar to fall too.
So it cut interest rates on Tuesday.
Trouble is, asset prices fell and the Aussie dollar went up.
The RBA failed. What does that mean now? We’ll explain…
The simple answer is that the interest rate cut you saw on Tuesday won’t be the last one you see this year.
In fact, due to the RBA’s misreading of the market, it’s likely that stocks will fall further until the RBA cuts again.
This is the peril of allowing central banks to set interest rates.
If the central bank didn’t exist, the market would determine interest rates purely according to supply and demand.
Where would that interest rate be today? It’s impossible to say. Rates could be higher than they are today, or they could be lower.
But that’s the point. A bunch of men and women sitting in a Sydney boardroom can’t possibly know what is the correct interest rate. The correct interest rate should be whatever the market decides it is.
You need cash for days like today
For some time we’ve warned you about piling into any old stock just to grab dividends.
The price action on the market over the past two days justifies that cautious approach.
However, we need to be clear on something: a nasty 2.3% fall doesn’t mean you should sell all your stocks…including your dividend stocks.
Stocks could keep falling after the RBA’s bumbling effort on Tuesday. But if you’re in the market, this is when you should look to buy, rather than sell.
It’s why we recommend only having around 40% (maximum of 50%) of your investable assets in stocks.
If you have all your money in stocks, you can’t take advantage of big pullbacks like this. But if you have plenty of cash set aside, when the market tumbles, you can look for opportunities to buy.
But again, just as selling shouldn’t be a knee-jerk reaction, buying shouldn’t be either.
Yesterday the market fell. Today it could bounce…and then fall again tomorrow.
Buying in just because the market falls or rises isn’t a sensible investing strategy. When the market is volatile, it can often pay to just stand and watch for a day or two.
That serves two purposes. First, it gives you time to judge the market’s direction — has it stopped falling, or has it kept dropping?
Plus, it gives you time to put in the extra research…to make sure that you really want to own the stock, rather than just buying something because it looks cheap.
Buy more of the same
As always, the best strategy during times of a big fall is to stick with what you know.
It still means waiting a day or two for the market to settle, but once it has, then you can look to top up on stocks you already own.
This goes back to something we wrote to you about recently, the idea of concentrating your stock holdings, rather than diversifying.
With concentrated holdings, odds are you’ll know the stocks inside out. You know whether they’re good companies. You’ve kept tabs on them…perhaps for years.
It means you don’t have to start your research from scratch. If you’re researching a new stock, it may take you days to get a full understanding of it. If the stock starts to rise when you’re doing the research, you may feel pressured into just buying it, even though you’re not completely convinced of the idea.
But if you’re buying something you already know, the decision should be easier. You still need to exercise some patience, but it should mean you’re in a good position to buy sooner.
In short, use this market downturn to look for opportunities to buy. And when you do buy, add to one of your favourite existing positions. You can research new ideas at the same time, but often, buying what you know is the best place to start after the market takes a tumble.
PS: Yesterday’s big fall is exactly why income expert Matt Hibbard made sure his subscribers didn’t overpay for stocks. Matt has a steady and sober approach to investing. That’s just what you need in this market. Go here for details.