STAYING THE COURSE WHEN INVESTING
A lot of us, as investors, are currently feeling somewhat woozy. An ever-weakening Rand driving inflation up across the board has put our wallets on diets with discretionary spend very limited. Rampant inflation and rising energy costs across the developed world has caused the central bankers to raise interest rates. This has put their stock markets under pressure and the JSE has followed global movement with a downward trend for most of the year. It is a tough environment to maintain a clear head but fortunately by sticking to the investment principles one will come out on the other side of all of this in a much better position. In this month’s Financial View, we look at how important it is to stay the course whilst investing and sometimes the best decision is not to make any changes.
Over the years we have often distinguished between saving and investing. Saving is the act of not spending all your income. Investing however is the specific act to put your savings to “work”. When investing the primary aim must be to grow the value of your capital in purchasing power terms. This is often quite challenging as inflation is a very destructive force. Like a mighty river, cutting a gorge through lands, it can leave lasting damage to an investment portfolio. In order to tame inflation, one needs to have exposure to those asset classes that should produce real returns which outperform inflation. In previous articles we have explained why exposure to the equity market is necessary as investments in listed companies have the best track record of producing returns in excess of inflation over the longer term. This is demonstrated by this long-term graphic created by Old Mutual where they have assessed the growth of R1 over 90 years after inflation i.e. that is growth in real terms. It is an almost a no brainer as over time equities (local or global) have delivered returns more than 20 times that produced by the next asset class.
The problem with equity investments is that they don’t deliver their returns in a straight line. Stock market prices are often driven by a combination of fear and greed. There is almost no middle ground, the market always seems to be overly optimistic or overly pessimistic with wild mood swings on a weekly basis.
These swings are caused by changes in sentiment and cause volatility in share prices as investors can see their portfolios up one day, down the next day even though not a single company within that portfolio has had any change to their business prospects. These short-term movements are what we would call noise. A change in the share price of a company, often doesn’t necessary reflect a change in their revenue streams or projected profits. It just indicates a change in market sentiment. The important thing when investing is to try to ignore the short-term noise.
Many investors do get caught up in the noise and look to switch out of the volatile equity investments and sit in the “safety” of cash. This is an understandable emotional behaviour as most of us don’t like pain or negative news. However, it can unfortunately be very destructive and negatively affect your investment value. Investors will rationalise and say that they can always return into the market in more favourable conditions. This almost never happens as stock markets turn very quickly. Mr Cash investor misses that initial bounce and then only once comfortable with the equity performance do they switch back into equity investments. Ninety One Asset Management have created a nice graphic demonstrating what typically would happen.
Over the 2 last major crashes they have shown what has happened to a portfolio if the investor doesn’t respond to the short-term noise (pink), what happened if they switched to cash at market low (orange) and what the performance would be if they switched to cash for a year before jumping back into the stock market (white). In both scenarios the investor has been better off by doing nothing.
Switching portfolios at times of huge pessimism means that one sells out at a low point. A point that invariably is trading at a large discount to the actual fair value of the instrument. Most of us like to receive discounts but are loath to offer discounts. 20% off chickens at Woolworths and many of us will be increasing our poultry intake. How many of us would be willing to pay 20% above retail prices for chicken?
Ultimately there are only two prices that matter when investing. The price you pay for the instrument and the price you receive when selling the instrument. Any price movements in between is just noise. But noise that often comes with future opportunities, especially in times of extreme pessimism. We do like to quote Warren Buffett as he is viewed as one of the world’s best investors. He famously once said that it is wise for investors “to be fearful when others are greedy, and greedy when others are fearful.” Now is possibly the time to be a little greedier. If you are investing and have a monthly debit order in place, try to make sure that you continue contributing and adding more units at a lower price. The longer you do this the higher your rewards will be when the markets turn, and favourable conditions return.
Recent Comments