There is a pretty simple rule in the world of investing: money doesn’t just disappear, it simply gets relocated to a new asset. Although, when you feel like you have lost money in an investment, it certainly doesn’t feel that way. So, if money doesn’t disappear, where does it go? More importantly, if I have an idea of where it goes, maybe as an educated investor I can take advantage of the big picture macroeconomic moves.
For starters, let’s look at the 4 basic locations for money:
- Equity Markets – These are the global stock markets, primarily focused on the S&P 500 as the most telling of global market involvement. The Dow Jones, Nasdaq and Russell are all highly referenced regarding the US markets. The Major international Equity markets like the German Dax, Londons FTSE and the Nikkei also offer investors the opportunity to invest in global equities. Typically, equity markets are popular when there is an air of certainty in the markets and people are not getting yields from Bonds. Speaking of bonds…
- Bonds, Treasuries and Fixed Income – These are typically used when investors are looking for some yield and principal protection. The process of many of these bonds, however, will fluctuate, and often times the investor that is buying into a bond fund thinks that there is no risk to their principal. It is important to understand how and when to use bonds as an investor. Typically, bond markets gain popularity with investors as they are looking to protect their capital and expect a decline in the markets.
- Commodities – Gold and oil are the most obvious of these, with gold being the most often used and talked about. Every day in the news, someone is talking about the price of gold, or the price of oil which tell us that there is a global focus. The biggest problem is that most investors do not know how to invest in these products without buying physical gold coin which many are reluctant to do. Gold becomes very popular in periods of uncertainty. A good case in point is that even though the US markets are rising after the election results, so too is the price of gold since many investors are looking for a “time- tested” investment.
- Cash – Good old cash, but which cash? Certainly, the US Dollar comes to mind, but cash can also be the Euro, Pound, Yen or any other currency that an investor in a particular country runs to. The bellwether is the performance of the US Dollar, since it hold the place as the world reserve currency. Investors move to cash in a time of panic. Often times, after a significant drop in the equity markets, many investors will move to cash simply to protect their investments. Especially in the USA, where a significant portion of peoples earnings go into employer matched 401K accounts, some investors will go to cash in times of trouble so they are still receiving the match without taking more risk.
Looking at those four, it’s interesting to think how money flows in good times and bad. There is a purveying thought that the markets move in cycles, going from bull to bear markets, with an overall uptrend purveying due to the swapping out of stocks in the measured indexes over time. Look at the attached picture:
This picture represents a bull and bear cycle and money‘s traditional flow over time. Notice that at market peaks, there is often a longer period of time. This is the time for professional investors to be able to start slowly offloading risk and moving into a more defensive position. The big question is, at those peaks when professionals are selling, who is buying? You got it, retail investors. Specifically the retail investors that are continuing to contribute to their 401K and retirement accounts by investing in mutual funds. Then at market bottoms, which are shorter in duration retail investors are closing their positions (selling) and going to cash. Who is buying down there? You guessed right again, the professionals. The professional investors know that most retail investors are late to the party to get in and late to get out.
When it comes to big picture investing in general, I like the advice about parties once given to me by a boss before our company Christmas party. He said “better to get there a little late and leave a little early so you can play again next year.”.Sound advice in many parts of your life.
Chuck Fulkerson is the Director of Student Development at Online Trading Academy, a leader in investing and trading education for any market or asset class. Fulkerson helps education individuals across the globe in what it means to be a successful investor and trader. He currently trades options as a swing and position trader; futures and currencies as a day trader; and equities as an investor to round out a truly diversified trading portfolio.
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