An open letter to new retail investors

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2020 so far has not been smooth sailing. A virus epidemic that was initially predicted to stay confined to one continent became a global pandemic.

Equity markets went into freefall, oil markets are experiencing never-seen-before plunges, and even the value of cryptoassets - which many thought to be a growing hedge market - started plummeting.

Retail investors' confidence in the markets has naturally taken a hit, particularly those who are newer to investing and have not experienced such levels of volatility.

We believe that anyone new to retail investing should use this time as an opportunity to deepen their knowledge of financial markets, understand why Covid-19 has had the impact that it has and to educate themselves on ways to stay afloat during these levels of uncertainty.

To support that process, we feel it is helpful to look at what history can teach us and consider the impact and aftermaths of previous market downturns.

The dot-com bubble

Global stock markets in the 1990s were experiencing some of their highest highs, largely thanks to the "dot-com bubble". But in Sept 2000, they nosedived.

The main cause of the stock market crash that year was the overvaluation of technology and internet firms in the bull market as the Internet was taking off and computing took on an increasingly important part of people's lives.

Investors were carelessly pouring money into internet start-ups, generating over-inflated valuations throughout the market.

The NASDAQ Composite rose from under 1,000 to more than 5,000 points between 1995 and 2000. With money flowing freely into the sector, start-ups were in a race to get big, fast, and spending accordingly. In other words, there were lots of cash-strapped dot-com companies that weren't actually turning a profit.

The 2008 global financial crisis

What started in the US with a depreciation in the subprime mortgage market in 2007 turned into what many economists called "the most serious financial crisis since the Great Depression" a year later.

The crisis saw global financial institutions like Lehman Brothers and Bear Stearns collapse, and others like insurance giant American International Group (AIG) needing a bailout by the US government.

While the cause of what was to become "the Great Recession" started in the US, the global economy suffered from the largest contraction in international trade ever seen at the time. Investors were sure this was something the economy would never recover from, and many abandoned the markets.

Market corrections

While the causes of both these financial crises were different, they both still resulted in a global economic downturn, which ultimately led to a market correction.

At the time, retail investors certainly felt like each event was unprecedented and the market had a slim chance of recovery. But ultimately there were positives to take away from both events.

When markets are doing well, they always run the risk of being overvalued. The declines we've seen this year, as well as those of 2008 and 2000, could be described as "necessary" corrections.

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And while the 2020 market plunge has been driven in response to Covid-19, one could argue that if it wasn't a global pandemic then something else may have triggered a correction in the near term to bring an end to the longest bull market in history.

Extended bull market runs can give investors a false sense of security and drive premium prices for stocks that are unsustainable over the long run. The sort of correction that we're experiencing at the moment thanks to Covid-19 is a healthy and often required part of the stock market cycle.

Education, understanding and knowledge of how markets work is critical to long term investment success. To help gain some perspective, I'd encourage new market participants to look more closely at why these crashes happened and the resulting recoveries that ensued.

New retail investors can use this as an opportunity to deepen their investment knowledge and explore buying opportunities by looking at sectors that may benefit from the current challenges, like utility and dividend stocks, or understanding why companies like Zoom have seen their share price rocket in recent weeks.

The Covid-19 pandemic has turned the world upside down and thrown financial markets into turmoil.

This may be particularly daunting for those who are new to investing, but this is also an opportune time to deepen your knowledge of the fundamentals of investing to prepare yourself for future success for when markets begin to recover.

Jasper Lee is the Managing Director (Asia) of investment platform eToro.

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