Staying the course

While it is human nature to behave in an emotional manner when it comes to something as important as investing, history has taught us that sticking to your guns pays dividends in the long run.

Ben Graham, Warren Buffet’s mentor, once said that the individual investor should act consistently as an investor, and not as a speculator. It is important to avoid material short-term focused and emotion-based changes to one’s investment strategy when looking to achieve a long-term investment goal. Fear is an extremely powerful emotion and fear about the financial markets, especially when it seems that markets are panicking, often leads to knee-jerk reactions that can cause significant financial losses.

Investors should instead be focusing on their long-term goals. There is always the temptation to change strategies and switch out of an underperforming portfolio. Remaining invested is however the best thing an investor can do to reach their investment goals. Past market crashes have shown that the ultimate winners of any market crash are those who stick to their long-term investment goals and remain invested. Switching out investments or changing investment strategies often yields the most inefficient outcomes, as investors would be realising their losses, and miss out on the inevitable recovery that always follows a market down-turn.

Buy-and-hold

Warren Buffett is quoted as having said: “Remember that the stock market is a manic depressive. Equity markets swing wildly from day to day, on the smallest of news rally, and crash on sentiment, and celebrate or vilify the inanest data points. It’s important not to get caught up in the madness but stick to your homework. We’ve made a lot of money in stocks over time, but there’s been years when we’ve lost money, too.” It would be difficult to argue that Buffett’s much reiterated “buy-and-hold” strategy has not worked for him up to now. Buffet’s investment approach is based around making informed decisions while taking a long-term view, then sticking with those decisions through market turmoil.

The Behaviour Gap

The term “behaviour gap” describes the difference between the higher returns that an investor may have achieved, and the lower returns that they actually achieve, as a result of their emotions getting in the way. Carl Richards is credited with coining the term and says the following on the subject: “You earn the investment return if you invest your money and then don’t touch it. No buying, no selling, just holding. But real people rarely invest this way. Real people chase performance and invest by looking in the rear-view mirror. It is precisely the hunt for the best investment that creates a phenomenon I have called ‘The Behaviour Gap’, the result of which is well documented. Because of classic behavioural mistakes, average investors almost always do worse than average investments.”

Performance chasing

Planning for the long-term should always form the basis of any financial plan. South African investors are, however, more likely to chase returns and switch between funds, believing that this short-term focussed strategy will lead to bigger gains, despite evidence to the contrary. Morningstar Investment Management South Africa conducted research into the area of investor returns and created a hypothetical “Performance Chaser” portfolio. In this portfolio investors switch their investments into the best performing fund from the previous year at the start of each calendar year. This is then compared with two portfolios managed by Morningstar – the Morningstar SA Multi-Asset Low Equity and SA Multi-Asset High Equity portfolios.

The research aims to illustrate the returns achieved by the performance chasers versus the returns achieved by investors that remained invested in their respective portfolios over the same time frame. The difference in the returns was significant. The Morningstar low equity portfolio returned 6.3 percent more than the Performance Chaser portfolio over a period of four years.

The difference is even more pronounced in the high equity portfolio. In this case, the Morningstar Adventurous portfolio returned 13.93 percent more than the Performance Chaser portfolio over a period of four years. The above scenario highlights the benefits of staying invested in a robust and consistent strategy as opposed to backtracking and chasing yesterday’s winners.

By seeking investment advice from a qualified financial planner, keeping the various elements of their investment plan aligned and by improving their knowledge about investments as well as remaining informed about their investments, investors will be able to successfully navigate the investment market storms on their journey to wealth creation.

The information contained in this article is of a general nature and intended for information purposes only. It is neither to be construed as financial advice nor to be regarded as a definitive analysis of any financial, legal or other issue. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult your financial planner/adviser to take into account your particular investment objectives, financial situation and individual needs.