Investors behaving badly?
The end of 2008 is fast approaching and with this for some comes the prospect of annual bonuses. As we know, many recipients will undoubtedly have over-spent during the year buying consumer products or the latest “must-have” items in anticipation of receiving ‘bonus-relief’. They will now have to use this much needed cash injection to repay the bank! The financially prudent amongst us who have managed their debt and spending patterns will have to decide what best to do with this excess cash. The question that those who are in this privileged position should be asking themselves is: “What is the best investment vehicle for my hard-earned money?”
The fascinating field of behavioural finance has shown that these kinds of decisions will be influenced by several emotional and cognitive biases which are heightened in times of extreme volatility, as experiences in the past few months. It is therefore essential that both clients and financial advisors have a framework within which they can identify, analyse and address their biases when selecting investment products or constructing investment portfolios. Although an alarming total of 50 systematic biases are understood to have an effect on investor behaviour; the most common ones that threaten investors in the current turbulent market conditions are referred to as the ‘regret aversion’ and ‘availability’ biases.
Regret aversion is an emotional bias and refers to the feeling of regret investors experience because they weigh up the questions of “what is” and “what could have been”. The massive downturn in the markets has left many investors regretting their decisions to invest in equities. The latest Association of Collective Investments (ACI) statistics clearly illustrate that retail investors have panicked with the majority of the flows going into money market (cash) funds – at precisely the wrong time! These people will regret missing out on the next equity Bull Run and will subsequently try to reinvest their money right at the top of the cycle, which will lead to them suffering the same fate again. When you are confronted with this bias remember the following quote from Warren Buffett (the world’s leading investor and richest man): “We simply attempt to be fearful when others are greedy and greedy when others are fearful”.
The availability bias is a cognitive bias and refers to the tendency to rely on the most readily available information in order to make decisions, not necessarily having confirmed its accuracy. Simply extrapolating recent personal experiences leads to an assumption that current trends will persist. By way of an example: the Yale Investor Confidence Survey gauges the investors’ general expectations with regard to anticipated market returns for the following twelve month period. In 1998 during the IT boom, 76% of US investors expected returns of 10% and higher whilst 20% of US investors anticipated returns of 20% and higher. Contrasting this to March 2001 after the dramatic unravelling of the IT boom, the majority of US investors anticipated returns in the region of 10% whilst only 8% believed that prospects for a return of 20% or more were good. Understandably, the same shift in sentiments has been experienced again across the globe during recent time, but this time unrelated to IT of course. Those same investors who believed a year ago that the strong performance of the equity markets would continue for at least the next few years have now changed their tune and are running for the hills! In order to avoid falling into the “follow the herd” trap, you need to remain focussed on your long-term goals. Most importantly, only adjust your portfolio when YOUR circumstances change, not when the market does.
Investors wanting to protect themselves against these biases can select a PPS Multi-Managed Fund that corresponds to their risk profile. This leaves the asset allocation, manager selection (and stress) to our qualified team of investment professionals. We have always maintained that you let the professionals do what they do best.
Research estimates that only 6.5% of South African investors can afford to retire at age 65. This is primarily because South Africans have earned low investment returns, paid high fees and have not saved enough. The first issue is easily circumvented by sticking to a long-term investment strategy. A long term strategy necessitates exposure to riskier assets, such as equities, that over time will generate returns above inflation. Always follow the motto: time in the market, not timing the market. PPS Investments addresses the problem of high fees by providing professionals with access to our range of discretionary and contractual savings products, such as the PPS Preferred Funds and the PPS Personal Pension Fund, at very competitive rates. No initial administration fees are charged on any of our products. In addition, any rebates on fees that we negotiate with our third party managers are passed back to our clients.
So, if you are one of those prudent few who have not fallen into the trap of not saving enough and have a couple of rand to invest, use the opportunity the recent market decline has provided and diversify your portfolio across all asset classes, including equities.
