In­vest­ing: low risk, high re­turn


The Citizen (KZN) - - Business - Pa­trick Cairns Look­ing over the hori­zon

A les­son on im­pact of mak­ing emo­tional de­ci­sion dur­ing pe­ri­ods of mar­ket tur­moil.

Over the past 25 years, the JSE has been through three ma­jor down­turns. There was the emerg­ing markets cri­sis in the late 1990s, the dot­com crash in the early 2000s, and the fi­nan­cial cri­sis that hit in 2008.

De­spite these set­backs, the FTSE/JSE All Share In­dex (Alsi) de­liv­ered an an­nu­alised re­turn of 13.6% be­tween Jan­uary 1996 and Novem­ber 2019.

At an av­er­age in­fla­tion rate of 5.8%, this means that in­vestors have earned real re­turns of 7.7% per year.

This is an out­stand­ing out­come for long-term in­vestors. How­ever, it’s likely that not ev­ery­one earned it, be­cause to do so you had to have the stom­ach to sit out these events.

From peak to trough in 1998, the Alsi fell 43.8%; be­tween March 2002 and April 2003 it dropped 36.8%; and in 2008, it took just six months for the in­dex to lose 46.4%.

The scale of these crashes would have scared many in­vestors out of the mar­ket. They would have seen their in­vest­ments rapidly los­ing value and with­drawn them to save them­selves fur­ther pain.

While this would have given them some short-term com­fort, it’s worth ap­pre­ci­at­ing the long-term im­pact of these kinds of de­ci­sions.

“Us­ing re­cent past per­for­mance as a proxy for fu­ture in­vest­ment re­turns ap­pears en­tirely rea­son­able,” says the head of re­search at PSG As­set Man­age­ment, Kevin Cousins.

“How­ever, at cru­cial points in the mar­ket cy­cle – typ­i­cally when val­u­a­tions are at ex­tremes – bas­ing in­vest­ment de­ci­sions on re­cent his­tor­i­cal re­turns can lead to very poor out­comes.”

To il­lus­trate this point, PSG looked at what would have hap­pened to the value of an in­vestor’s money if they had with­drawn it af­ter each of the three mar­ket crashes since 1996, and only re-en­tered the mar­ket a year or two later. The re­sults are il­lus­trated in the graph.

An in­vestor who stayed out of the mar­ket for one year af­ter each crash be­fore putting their money back in would have seen a real re­turn of only 2.7% over the full pe­riod. In nom­i­nal terms, they would have a lit­tle more than a third of the money they would have had if they had stayed in­vested through­out.

Some­one who with­drew their money and kept it out of the mar­ket for two years on each oc­ca­sion would only have earned just more than in­fla­tion.

Their to­tal would be less than a fifth of what they could have had by leav­ing their money where it was.

“While this is a stylised ex­am­ple – we have not in­cluded in­ter­est earned while out of the mar­ket and did not deduct any fees or trans­ac­tion costs – it clearly il­lus­trates the im­pact that mak­ing an emo­tional de­ci­sion dur­ing pe­ri­ods of mar­ket tur­moil could have,” Cousins points out.

While this fo­cuses on ma­jor mar­ket down­turns, in­vestors should think about the wider les­son as well.

His­tor­i­cally, over any rolling five-year pe­riod, the JSE has never de­liv­ered a neg­a­tive re­turn.

Over any rolling 10-year pe­riod, it has failed to de­liver an above-in­fla­tion re­turn only 5% of the time.

This shows that the risk of los­ing money for a long-term in­vestor in eq­ui­ties is low.

The po­ten­tial gains from stay­ing in­vested, on the other hand, are high. Over the past 90 years, the mar­ket has pro­duced an an­nu­alised re­turn of 13.8% per year. That is dou­ble what has been avail­able from cash.

It il­lus­trates im­pact of an emo­tional de­ci­sion.

Source: PSG As­set Man­age­ment, Bloomberg

STAY IN­VESTED. Dis­in­vest­ing af­ter mar­ket de­clines can dra­mat­i­cally erode in­vest­ment out­comes.

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