John Bogle, the founder of the US investment company Vanguard, calculated that the average equity unit trust investment gained 173% between 1997 and 2011. In the same period, the average investor in equity funds gained only 110%! This is primarily because investors end up selling when the bear prowls and buying when the bull rages. Discover more about the importance of staying the course…
Hold onto your chips when the market dips
When stock markets fall, it’s very natural to want to sell your shares and invest in less risky assets like cash and bonds, in an attempt to avoid further loss. To do this, however, is to lock in a loss forever. If your share portfolio falls by twenty percent (a normal occurrence in the course of investment cycles) and you sell, the loss becomes permanent – as opposed to a ‘paper loss’.
Another important point is that if your investment drops in value and you sell, you need to achieve a higher return to get back to the initial value. For example, if your investment drops from R1 million to R800,000 and you sell out, you must achieve a 25% return to get back to your original value of R1 million. This is highly unlikely in the short term.
Because no two investment cycles are the same, nobody knows when the markets will turn for the better – not even the smartest analysts. If you’ve sold out, you may very well miss out when the bull starts to run again. The bull is unpredictable and very fast: you can’t afford not to have a finger in the pie during the best performing days.
The proof is in the pudding
Still not convinced? Let’s look at some figures. The research company Morningstar did an analysis using the JSE All Share Index to demonstrate the difference in returns between an investor who decided to stay the course, and three other investors who missed out on the 10 best days, the 20 best days and 50 best days, from October 2013 to October 2018. The study assumed that all four investors invested R1 million in October 2003. At the end of the cycle:
- The investor who stayed invested was worth R 5.4 million.
- The investor who missed the 10 best days (by trying to time the market) was worth R 3.1 million.
- The investor who missed out on the best 20 days was worth R 2.1 million.
- The investor who missed out on the best 50 days was worth R875,000 – a loss of R125,000.
Phase in, or take the plunge?
Now that we’ve proven the importance of staying the course let’s move on to another important question. If you’re sitting on a lot of cash (you may have sold your holiday house or received a great bonus) should you phase in the investment over a period of 6 to 12 months? Or should you take the plunge and invest a lump sum in equity that has recently underperformed?
Phasing in may sound like a good way to minimise risk, but research by Sanlam indicates that phasing in is generally not a good investment strategy. Looking at the period from July 2000 to July 2015, Sanlam found that 83% of the time, a lump sum investment outperformed the phase-in method (for high equity shares).
That said, you do need to consider human emotions. Most of us suffer more from the pain of loss than we benefit from a gain, and if you’re the kind of person who keeps checking up on his/her investment performance, it can be tricky to stay the course. If you can’t stomach taking the plunge, phasing in is a far better bet than not investing at all.
Bulls and bears
Don’t make the mistake of trying to tame these two unpredictable beasts. The markets have always been cyclical and their returns lumpy – this is not going to change. Think back to the dips in 1929 (if you’re that old!) 1987 and 2008. Remember, that despite their cyclical nature, the markets’ long-term trend is always upwards. The best way to decrease loss (and thus increase the growth of your investments) is through a diversified portfolio that has been compiled by a qualified financial advisor. (While we’re on the topic, don’t forget to rebalance the asset allocation at least annually so that your investment strategy stays true to your goals.)
The final word
History has a funny habit of repeating itself. While it may be hard to watch your investment, portfolio takes a short term hit, you’ll do far more damage to your financial future by panic-selling and thus locking in your losses. If in any doubt, remember that I’m always only a phone call away.