Behavioural science has shown that loss aversion – a strong preference for avoiding a loss over making an equivalent gain – and recency bias – our tendency to attach more significance to recent events than to events in the past – are inherent behavioural biases that all of us share.
These biases are often all too evident in how people approach investing.
Last year marked the FTSE/JSE All Share Index’s worst year since the global financial crisis, with the overall index down in rand terms at year-end. Even more discouraging was that this signified one of the worst five-year periods the local market had seen in decades, deepening investor disillusionment.
Although the local market recovered somewhat in the first quarter of 2019 (driven largely by rand hedges), a weak economy and heightened political tension have added to the unease. The escalating threat of international trade wars and geopolitical disruptions have caused similar scepticism towards many global markets.
Given our loss aversion and recency biases, it’s easy to understand that heightened uncertainty and disappointing investment returns may have tempted investors to switch out of investments that have recently performed poorly, or to exit the market completely. However, staying the course improves the odds of favourable long-term investment outcomes.
Research has shown that most investors are notoriously bad at market timing. This means that investors who disinvest to try to lower their risk, run the very real risk of missing out on a potential market recovery. By selling when prices are low, investors may lock in losses, especially if they only re-enter the market once prices have already started climbing.
While we know that it’s incredibly difficult to act against ingrained instincts, a long-term mindset and consistent approach are critical to investors achieving their desired objectives. We recognise our responsibility both to apply these principles, and to encourage investors to do the same.
We often note that the best opportunities are found in times of fear and uncertainty. Moments of panic invariably result in the prices of quality companies and securities falling along with the rest of the market.
While it may be difficult or feel uncomfortable, capitalising on these low prices creates the potential for outsized returns once the panic passes. We are currently finding such opportunities not only in equities but across almost all asset classes. This is rare, and allows us to construct diversified portfolios with good odds of achieving their client mandates under a range of possible future outcomes.
The true power of a properly diversified portfolio is that it helps you to achieve your goal even if you get some things wrong along the way. Investing is about dealing with an uncertain future. Diversification and a long-term outlook can help to manage that.
