South African investors are their own worst enemies by trying to time the market, buying when they think prices are low and selling when they think prices are high.
Momentum Investments head of behavioural finance Paul Nixon told CNBC Africa that South African investors generally lose out when trying to time the market.
“People with long-term investment goals, our research finds, actually behave more like short-term traders,” Nixon said.
This results in them paying what Nixon calls a ‘behaviour tax’ on their investments as they lose out by buying and selling investments impulsively.
The general rule of investing is to buy low and sell high. However, investors try and time market lows and highs perfectly to maximise returns.
While this seems intuitively correct, it does not work over the long term as one cannot regularly time the market.
“Trying to time the market generally does more damage than value addition,” Nixon said.
Data from Momentum Investments indicates that in one year during the Covid-19 pandemic, investors lost R650 million by paying a ‘behaviour tax’ on trying to time the market.
The lesson here, Nixon said, is to focus on your long-term investment goals and look beyond short-term market fluctuations.
“If your goals are not changing, the strategy to reach those goals should not be changing either.”
Investors should focus on the chances they will lose money in an investment as that is what risk fundamentally is, and one should not have to take an outsized risk to earn a return on investment.
The perception of risk forces investors to pull out of investments prematurely and abandon an investment strategy. Thus, it is critical to manage the risk of investing.
Nixon recommended investors ask four questions to manage the risks they are taking –
Is the risk more than you can afford?
Before buying into an investment, investors should assess their financial situation to determine whether an unforeseen event or an emergency may force them to liquidate their investment prematurely.
Nixon recommended investors establish an emergency fund before investing to shield themselves from having to abandon their investments prematurely.
How much risk are you comfortable taking?
This is a difficult question to answer as it is fundamentally psychological.
Superinvestor Bill Ackman has a simple way of answering this question by asking another, “Can you sleep well at night?”
This ‘sleep-at-night test’ is critical to Ackman’s investing strategy and his company, Pershing Square.
Ackman asks three questions as part of this test:
- Can I sleep well at night knowing that I have invested in this company?
- If the company’s stock price were to decline by 50%, would I still be comfortable with my investment?
- If the company were to go bankrupt, would I be able to recover my investment within a reasonable timeframe?
How much risk do you need to take to achieve your investment goals?
Nixon said the answer to this question depends on the time horizons of your investment goals.
Generally, the longer the investment horizon is, the more risk investors should be able to take, as they can ignore short-term market fluctuations.