Investment sentiment has turned quite negative in recent weeks. Virtually all stock markets around the world are down in 2018 with emerging markets leading the way as trade wars, rising US interest rates and a firmer dollar take their toll.
In times like these, the rand usually takes a beating, no matter what, so no surprise it’s down 13% against the dollar over the past three months. Although cyclical factors are at play – essentially the end of America’s cheap money policy – many local investors still see this as a vote of low-confidence in South Africa. The sense of optimism from six months ago is gone, and so is the appetite to invest locally. If foreigners don’t trust our market, why should we?
Throw in our home-made troubles on the economic, political and corporate front, and it’s tempting to just hunker down and avoid making any kind of investment decision in your personal finances.
If that means sticking to your original, well-considered plan, then carry on. Giving in to your emotions or reacting to short-term market turmoil inevitably leads to a worse outcome.
But sometimes an investment decision cannot be avoided, say because you’ve come into a cash lumpsum, or you’ve just retired, or you can’t afford to delay retirement saving any longer.
Ideally, in that scenario you will put on your (market) noise-cancelling headphones and devise an investment plan that will give you a good chance of hitting your financial goals. A plan, in other words, that ignores what markets are doing right now and instead considers what they are likely to do over your investment term, be it a year, 10 years or 40 years.
There are no guarantees, of course, but there is a hundred years of financial market history to help guide your decision.
The temptation is to do the opposite, to follow your emotions and invest according to the prevailing sentiment. But that’s a bit like driving with your eyes on the rear-view mirror. Chances are you’ll end on the ‘buy high/sell low’ road to a really poor outcome.
With so much negativity around, you may believe there’s no point saving at all right now. But saving is critical, even during low-return periods.
Much is made of the power of compounding. Once you have saved for 20 or 30 years, the annual growth in your savings that comes from your expected (average) investment return will completely dwarf the contributions you make in those years. (by a factor of 30 or more in an average year).
But this compounding phenomenon relies not just on past returns but also on how much you have saved in the past. If you don’t save consistently in the early years – even in the face of modest returns – you won’t have the base needed to deliver large compound returns in future years.
It’s also tempting to hold cash right now. Over the last three years, cash has delivered considerably more (around 7% pa) than the local equity market (around 4% pa). Why take on market risk if you can earn a higher and more secure return simply by parking your savings in the money market?
Holding cash preserves your money short term and it can provide you with the ammunition to take advantage of a short-term market correction. But it will not deliver the returns you require long-term, to achieve your retirement goal, or stretch your savings in a living annuity. Historically, the long-term return from equities has been around 5% pa higher than for cash.
If you are planning to switch out of cash into equities at the opportune time, you should appreciate that getting the timing right is difficult. Equity markets turn well before sentiment does. And equity returns tend to be quite lumpy. They don’t deliver smooth annual returns; much of the action happens around the inflection points.
Missing out on the initial bull market gains can cost you many years of the “annual average return”. Or it may cause you to stubbornly stay out of the market altogether, waiting for the next big crash to get back in. Some investors have been waiting for that opportunity since 2009.
Investment uncertainty is inevitable but agonising over your investment decisions is optional. You may feel that the outlook is less certain than ever before, and that South Africa’s prospects are bleaker than ever. But ask any investing old-timer, and they will tell you we have here many times before over the past 40 years.
Especially during times of chaos, the prudent approach is to anchor yourself to the essential elements of investing: choose your asset mix with your goal and your time horizon in mind; diversify well; keep it simple; minimise costs; don’t play at market timing; optimise your outcome, by occasionally rebalancing; and don’t let your emotions overrule your strategy.
Take some time to design and document your plan. Research suggests that will make you more committed and more likely to stick to it.
Following this approach may not give you the very best outcome, but it is likely to give you a better outcome than most other strategies.
