Investing In Shares And The Panic Caused By A 'fat Finger'
On Thursday the 6th of May 2010 the US market plunged more than 900 points in under half an hour
, but then later in the day found its feet and recovered to end the day down 340 points.
What caused this fall is still being investigated but a typing error could be partly to blame. Urban legend has it that a dealer mistakenly hit the "b" for billions key rather than the "m" for millions sending a far larger sell order into the market than they intended.
What is far more concerning is the panic selling this "fat finger" mistake appeared to have caused. Automatic computer models were sent into immediate overdrive and many hedge funds and traders who use these systems sent a wave of sell orders into the market, not only in the US, but right around the world.
Investing in shares is a pursuit that involves a lot of uncertainty. Optimists might call this excitement. I prefer to call it uncertainty. Sometimes markets react rationally to news, but at other times they behave completely and utterly irrationally. The widespread use of computer systems only adds to this mindless volatility. Pun intended.
Returns from shares are unpredictable and volatile. I know that sounds like a stockbroker shooting himself in the foot, but trying to convince people to buy shares because they offer any degree of certainty in terms of future returns is simply false advertising.
It is true that shares offer the highest potential returns, but people should not invest in shares under any misconception that these returns are certain.
Even with diversification, returns from shares are undeniably volatile. This reality makes the market forecasts that we all do of limited value. Nobody knows how the market will perform in future.
For those not liking the sound of the uncertainty that comes with investing in shares, the alternative strategy is to shun shares in favour of the certainty that comes from investing in fixed income. But of course, returns are lower. After a quick scan of websites, it is pretty clear that you can get rates of around 5.5% from banks at the moment "" a very good rate considering the Official Cash Rate is just 2.5%.
However, if we take off tax at 30% we are left with a net return of 3.8%. Then we need to consider inflation. We are forecasting inflation to increase. If we assume a CPI of 2.5%, taking this away from the net return leaves a real return of 1.3%pa.
By comparison, the 8.2% gross return from shares, after deducting tax on dividends of 1.1% and inflation of 2.5% leaves a net real return of 4.6%.
What about that other alternative to shares, property? Property is a good investment, but only for those who understand that the expectation that property can deliver "ten-percent-a-year, every year" is completely unrealistic. Although returns from property are slightly more reliable than those from shares, they are still volatile, especially when leverage is involved.
But then again, nobody said investing was easy; and actually, the moment it feels easy, get worried.
by: Cam Watson
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