Ground rules for investing in tough times

Anet Ahern, CEO, PSG Asset Management

There’s no denying that the current narrative in South Africa is negative. Investment returns have been poor for some time and there seems to be no light at the end of the tunnel appearing just yet. During times like these, emotions can run high and investors can make costly mistakes. It is therefore important to focus on your long-term goals to avoid making panic-driven decisions that could lead to losses down the road. The markets are tough, but remembering a few essentials should see you through.

Don’t try to forecast and don’t rely on the recent past either

There’s no one in the world that can tell you with 100% accuracy what will happen next. Markets are influenced by thousands of factors and to date, no one has found a way of aggregating these in a sensible way that allows investors to make predictable, informed decisions. Anyone who claims to be able to forecast market conditions is either overly confident in their own abilities or simply disingenuous. That’s why it’s important for investors to value long-term thinking (allowing for short-term fluctuations to average out) and a consistent investment approach (which should prevent the losses that can result from impatient or emotional portfolio changes). A common forecasting mistake is to believe that the most recent experience will continue. For example, cash would have done better than shares for the past few years, so it will continue to do so. What makes it even more tricky is that projecting the recent past often works in the short term – hence its popularity. However, the strategy tends to fall short over the long term.

Think long term

This is a concept that many investors are probably sick of hearing, but it remains the best way to approach your investments. A long-term approach cancels out the day-to-day fluctuations in value that result from herd behaviour and market noise. Investing is a concerted effort to build your wealth over the course of years or even decades. Focusing on short-term, inherently unpredictable outcomes is the riskiest way to go about building wealth.

Diversifying is the one free lunch in investing

One of the biggest mistakes an investor can make is to rely too heavily on one method of investing, be it an over-reliance on a single fund, share, exposure to a single sector or even a single asset class or currency. Investment portfolios should be well diversified in terms of the blend of assets in which they are invested, the range of companies they are exposed to, the sectors in which such companies operate and also the geographies to which the investor is exposed. A well-diversified investment portfolio should be able to withstand downward trends in local markets or unexpected corporate failures.

Short-term thinking is also the enemy of diversification, as many asset classes can behave similarly during times of extreme market sentiment, be it negative or positive. For example, when sentiment towards a country is negative, both bonds and equities may perform in a similar way regardless of valuations. But in the long term, being invested in a diversified way improves your chances of achieving your goal.

Buy with a margin of safety

‘Margin of safety’ refers to the margin between the price of an asset and its intrinsic value. Ideally one wants to buy something that is worth one rand for sixty cents or less. Maintaining a healthy margin of safety within your investments will allow you to ride out rough spots in the markets without panicking about a particular investment’s future potential. Markets are driven by the buying and selling patterns of inherently irrational humans who are strongly motivated to act by their emotions of fear and greed. This frequently leads to assets temporarily being valued at more or less than they are actually worth.

Remember that times of panic often give rise to opportunities

During times of panic, many companies become undervalued due to the negative investor sentiment that seizes markets, and then they become even more undervalued as panic selling drives prices down further. We saw some if this behaviour around the globe in August. The thing to keep in mind about quality assets is that trading prices will usually return to ‘pre-panic’ levels eventually, so buying good companies and other assets when prices are depressed can lead to considerable success further down the line. It’s about sticking to your strategy, avoiding getting caught up in emotion, and remaining focused on your long-term goal. These are basic principles that are increasingly difficult to apply in times of uncertainty and which merit reaffirmation.