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

Weekend Argus (Saturday Edition) - - PERSONALFINANCE -

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.

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.

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.

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.

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.

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