Why chasing market trends is a bad investment strategy

The JSE shed 6.5 percent within two days of the Brexit announcement, leaving many investors unsure whether to weather the storm or move to cash. Some number-crunching by an investment actuary indicates that you should sit tight. Mark Bechard reports

Has Brexit left you feeling panicky about your investments? Do you think you should sell out of volatile equities and head for the calmer waters of cash? Your best response might be to do nothing, because the latest research suggests that investors pay dearly whenever they try to time the markets.

“When markets crash, as we’ve seen since the Brexit announcement, our first instinct is to panic and withdraw, just as we are tempted to chase returns when markets are running. However, this often means that you will end up buying high and selling low. The best thing you can do for your money is to spend time in the market, rather than trying to predict what will happen,” Hildegard Wilson, a member of the Actuarial Society of South Africa’s investment committee, says.

To illustrate the importance of spending time in the market rather than trying to time the market, Wilson did some calculations around one of the biggest market crashes in recent years – the 2008 global financial crisis – to show how your investment choices affect the outcome. She analysed four different scenarios in which the decision to stay invested or to chase market trends had a significant impact on returns. Scenario 1: Ride it out. You invested R10 000 in a South African multi-asset high-equity fund on January 1, 2008. These unit trust funds invest in equities, listed property, bonds and cash, according to the fund manager’s discretion. They can have a maximum equity exposure (including international equity) of 75 percent and a maximum listed property exposure (including international listed property) of 25 percent.

Shortly after you invested, the subprime mortgage crisis in the United States sparked panic among international investors, resulting in a mass selloff in emerging markets, such as South Africa. The FTSE/JSE All Share Index (Alsi) lost a huge amount of value from the end of 2008, reaching a low in early March 2009, before rallying, with growth of 53.1 percent by the end of that year.

The Alsi gained 121.97 percent in value in the eight years between the beginning of January 2008 and the end of December 2015, or an average of 10.48 percent a year.

In this scenario, you stayed the course through all the market’s ups and downs until December 31, 2015. Based on the average return (net of fees) of the South African multi-asset high-equity sector, your investment more than doubled to R20 542 over the eight-year period. You made an average annual return of 9.42 percent, while the average annual inflation rate over the period was 5.87 percent.

The bottom line: you more than doubled the value of your investment, which, on average, out-performed inflation by 3.55 percent a year. Scenario 2: One wrong call. Again, you invested R10 000 in a South African multi-asset high-equity fund on January 1, 2008. However, after watching the market value of your investment drop from R10 000 to R8 267, you decided, on March 1, 2009, to move your money into a money market fund, because cash is considered a less volatile investment. Wilson points out that when you switched, you effectively locked in your losses – in other words, you forfeited the opportunity of being able to recover them once the market turned.

You saw the JSE recover substantially after March 2009, so, on January 1, 2010, you decided to reinvest your money in a multi-asset highequity fund, seeking more aggressive returns.

Based on the average return (net of fees) of the Short Term Fixed Interest Index, which measures money market instruments, your investment would have totalled R8 854 on January 1, 2010.

After switching, you stayed invested in the multi-asset fund. After nearly five years, your investment totalled R17 549 (after fees), representing an average annual return of 7.28 percent, while the inflation rate was 5.87 percent.

The bottom line: your attempt to time the market cost you nearly R3 000, compared with scenario one. Your investment did, on average, out-perform inflation each year, but by 1.41 percent instead of 3.55 percent. Scenario 3: Two wrong calls. You did what you did in scenario two, but in 2013 you again switched out of the multi-asset high-equity fund.

The beginning of 2013 saw what was called the “taper tantrum”, when international investors panicked in response to the US Federal Reserve’s announcement that it would start reducing the measures it had used to boost the US economy following the global financial crisis. At the time, you were invested in the multi-asset high-equity fund, but, after this announcement, you decided to disinvest in an attempt to time the market and “protect” your investment. You disinvested on July 1, 2013, when your funds totalled R13 144, and put this money into a money market fund.

During the year that followed, it became clear that the US central bank had adopted the correct approach, and, following market trends, you reinvested in the multi-asset fund on August 1, 2014, with total funds of R13 909.

Your caution meant that you lost out on 13 months of market growth. On December 31, 2015, your investment totalled R15 329 (after fees), representing an annual average return of 5.48 percent.

The bottom line: your two mis-timed decisions resulted in you losing more than R5 000, compared with the first scenario, and under-performing inflation by an average of 0.39 percent a year. Scenario 4: Two wrong calls with a passive investment. You decided to invest in a passive portfolio, rather than an actively managed unit trust fund, and, on January 1, 2008, you placed R10 000 in an exchange traded fund (ETF) that tracks the Alsi.

You panicked following the global financial crisis and disinvested on March 1, 2009, when your funds totalled R6 545. You put the money into a money market fund and, on January 1, 2010, when your funds totalled R7 010, you reinvested in the ETF.

After the “taper tantrum”, on July 1, 2013, you withdrew your funds, totalling R10 705, and put money into a money market fund. You then reinvested in the ETF on August 1, 2014, when your funds totalled R11 340.

On December 31, 2015, your investment totalled R11 554. By timing the market, you achieved an annual average return of only 1.82 percent.