EquitiesSep 5 2018

Leave speculation to the gamblers

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Leave speculation to the gamblers

When we see headlines screaming ‘panic’ and ‘sell’, the investor, scared of losing his/her money, sells.

The problem the investor then faces is when to buy back into the market. 

By rushing to sell, the investor may lose any profit they have already made, and runs the risk of greater losses due to fees and market uncertainty. 

Remember, when markets are falling, stock prices are falling – you can only sell if there is a buyer to sell to. If a buyer is found, you should then ask, ‘if the buyer thinks the stock is cheap enough to buy today, why am I selling it’? 

Many investors do not ask this question as they are too keen to get out of the markets.

That is why I often hear investors say, ‘I don’t buy equities as I lose too much money’. It is not the equities that have lost the money, it is the result of investors’ behaviour based on their faulty reasoning. 

We know that over time unless we invest in something, the value of our capital will decrease because of inflation.

If you stay invested and the markets keep falling, you become anxious about the money you have lost – particularly when you could have pulled out earlier.

If the portfolio value falls below the amount you invested, you now have a paper loss, but if you sell you will create a real loss. If substantial, this loss creates a real fear. Can you really afford to lose this money? 

The worst scenario is that the investor’s nerve goes and they sell at the bottom.

After a few months the markets begin to turn positive and the time for optimism begins, but the investor has been burnt and will not be burnt again, so they hold out just in case it’s a false rise.

The market keeps climbing, but the investor is still nervous about going back in. The media is now all excited and is talking about the bull run. Everyone’s making money, so at last the investor gets their optimism back and they jump into the market.

However, they may be too late because all the gains have been recovered and they still have their losses to make up. 

Or the investor reinvests and then the markets fall, and the cycle of faulty reasoning continues.

Investing for today

Why do we invest if we are so scared that we will lose our money? We know that over time unless we invest in something, the value of our capital will decrease because of inflation.

The problem we have is that it is impossible to make good money decisions all the time. If we invested for today’s market conditions, tomorrow it could all change.

If we are out of a particular global market we may not recoup the lost growth for many years. 

If we then change our stocks again to capture tomorrow’s market returns, then we are reducing our capital value as a result of buying/selling fees and taxes. This is not the way to invest but unfortunately many investors do this.

Key points

  • When markets are falling, the temptation can be to panic.
  • If the investor loses money, they can be nervous about getting back into the market.
  • Limiting investments to a handful of stocks is risky.

How to invest

There are more than 98m trades a day in the global market which is an effective information processing machine. The real-time information from trades helps set the market price. 

Rather than buying retail funds selected by a fund manager, buy a diversified basket of global index tracker funds and let the markets work for you. Holding a wide basket of stocks from around the world, linked directly to market returns, can reduce the risk of trying to outguess the markets, or worse, paying somebody to outguess the markets.

Investment returns are random: they cannot be predicted with any great future certainty. Therefore, no one can say, with conviction, which financial sectors an investor should buy to get the next best return on their investments. 

Therefore, limiting an investment universe to a handful of stocks, or even to one stock market, is a concentrated strategy with high-risk implications. 

Do not try and guess which parts of the world will outperform others, or whether bonds will outperform equities, or if large stocks will outperform small stocks. Buy the global market using a diversified basket of index tracker funds and leave the speculation to the gamblers. 

Be patient

Investors should be patient. It is not a good idea to jump the minute the market starts to drop. Manage the investor’s emotions by encouraging them to invest in a risk portfolio that is correlated to their capacity for loss, not one that is based purely on your search for the highest returns.

Remember, investing is for the longer term. History says you will be rewarded for your bravery – and patience.

Ensure you have a cost-effective (that is, low fee) portfolio. It is the hidden fees and costs that are taken from your fund as service costs, annual management charges and discretionary management that are often unnecessary.

Try keeping the costs of managing the client’s portfolio to less than 1 per cent.

The industry average cost of using a conventional financial services company is in the region of 2.3 per cent. Saving even 1 per cent a year will have made a substantial amount of money using compounding interest over the life of the portfolio. 

Finally, try to manage emotions around investing. When the client wants to invest, select a diversified basket of index tracker funds invested globally, and the investor should hold their nerve, even when markets are falling. And keep the fees below 1 per cent.

Hannah Goldsmith is founder of Goldsmith Financial Solutions and author of ‘Retire Faster’