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I have already talked about the emergency fund before. Today, we are going to cover a different kind of fund: the opportunity fund. It is not as well-known as the emergency fund. And it is not nearly as used at the emergency fund either. However, I think it is important to know what it is.
As its name indicates, this is a fund that contains money waiting for an opportunity. The idea is to get ready for investing opportunities. The best opportunity in the stock market being a full-blown bear market. In this post, we are going to see exactly what purpose this kind of fund serves. And also I am going to discuss its downsides.
The opportunity fund contains money that is available for buying opportunities. The goal is to have money at hand when you see a good opportunity on the stock market or the real estate market or even another kind of goods. If you have an opportunity fund, you should already know what is a good opportunity. I think that there is no point in having one if you do not know what you are waiting for.
This fund should be stored in a highly liquid account. You do not want to wait several days before the money is available. The best place to keep an account like this is in a high yield savings account. Of course, currently, high yield means no interest in Switzerland. But there are some countries that offer high yield interest accounts. Another good idea is to keep all the money in your broker account. That way, you are sure the money is available at the correct time.
Some people store their opportunity funds in bonds. I am not sure it is a great idea. Even though bonds are generally more stable than stocks, there is still a risk. You may have to sell at a bad moment and losing money. If I had an opportunity fund, I would not invest it. I would keep in cash. I think the best place is in your broker account.
Why are people keeping an opportunity fund? Currently, the stock market is at very high levels. Of course, that means that people who invested early in the bull market are now very happy. But that also means that buying now is very expensive. Some people think that prices now are too much inflated and there are not enough good opportunities in the current market. They are afraid that investing right now will not yield any good returns. Therefore, they are stashing money away to be ready once an opportunity is coming.
The best opportunity you can wait for is a bear market. A bear market is a time during which the stock market value has lost at least 20%. There have been many bear markets in history. Generally, they are shorter than a bull market. Generally, a bear market is often accompanied by a recession. A recession is happening when the Gross Domestic Product (GDP) is falling for two consecutive quarters. Often, a recession and a bear market are coming at around the same time, one causing the other. You may not wish a recession. But if you are a long-term investor, you may wish for a bear market.
Some of you may have been asking themselves this question: is not that market timing? It totally is market timing. An opportunity fund is totally related to market timing. And people with an opportunity fund know that. They are expecting the market to go down and waiting for the next bear market to invest more money.
Is not market timing bad? I think it is not a great idea. If you could predict the market accurately, then it would be great practice. But it turns that you cannot. However, when you are investing, at some point, you can start to worry about the large prices of what you are investing in. We are currently at very high levels of valuation in the stock market. A lot of people are saying that the next bear market is close at hand.
When the next bear market hits the stock market, they want to keep their money and invest it when the opportunity comes. A bear market is not necessarily a bad thing. On the other hand, a recession is generally not something you want! There are two things you need to do in a bear market. First, do not sell! And continue to invest! It is true that the best discounts you will find are during a bear market. If you have a large opportunity fund, you may make a lot of profit from it.
When will the next bear market be?
That is the million dollar question! If you can precisely predict the next bear market, you will be able to make a lot of money. You could sell everything the day before the drop and reinvest everything at the market lows. Then the second question would be, when will we be at market lows? Again, another million dollar question.
Nobody can accurately predict the date of the next bear market. And nobody can predict its end either. You may have read stories about people who accurately predicted the crash of 2008. However, for one people who accurately predicted it, there were one thousand persons who got it wrong. It is a simple probability. A few people were just lucky in predicting it. I am pretty sure that they will not be able to predict the next one.
There are some signals that could show that a bear market is nearing. However, this will not help you predict it exactly. I cannot tell you when the next bear market will hit us. However, we are at the top of a very high bull market. The current market did not see any correction of 20% of its price in more than nine years. This is one of the longest bull markets in history. That means that the chance of the next bear market being close is high. What we can say for sure is that there will be a bear market at some point. It could be tomorrow, but it could be in 10 years. If I had to make a prediction, I would say that it will hit in the next two years. But it is a pure guess, do not take my word for it ;)
It is kind of ironic but an opportunity fund has an opportunity cost. By keeping your money out of the stock market, you are losing on potential gains. Imagine that you are making the bet that the stock market will enter a new bear market in the next year. You are keeping your money out of the stock market. If it really does enter a bear market, you have money ready to invest at good prices. Then, what if it does not? Imagine that the next bear market does not come for 10 years of the bull market. You may have lost a lot of money in the lost opportunity.
Even though I do not want to do some market timing, I can see the pros of an opportunity fund. However, I do not think you should stay entirely out of the market. At the current stock valuations, I think it makes sense to keep some money out of the market. But putting all your savings into it and delaying all investment may not be a great move. You really need to know what you are doing when you are timing the market.
An opportunity fund is a tool for market timing. If you think that the stock market will crash soon, you stash some money in an account, ready to be invested when the bear market comes! But be careful with this tool. If the bear market you are waiting for ends up not coming for 10 years, you will have lost a lot of opportunities. This is market timing!
As long as you are aware that it is market timing and that you are ready to pay the consequences of it, an opportunity fund is not a bad thing. But it is not for everybody. I do not recommend everybody to get an opportunity fund. But I think it is important to know what it is! And if you have already a large portfolio, it may be more interesting to get some more cash at hand.
If you are interested in the emergency fund, you will be interested in the emergency fund as well.
What do you think about opportunity funds? Do you keep one? When do you think the next bear market will hit?