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Don’t allow your emotions to control your future returns

If we remain on the sidelines because we seek comfort, we miss out on opportunities.

After getting through the pandemic, all of us thought that 2022 would be a year in which global economies would reopen, travel and tourism would start picking up again and supply chains would start normalising. Instead, we have a war in Eastern Europe, oil prices that have shot to the moon and increasing fears about spiking inflation.

Needless to say, markets did not react positively to the above, the S&P is down 22.9% since the beginning of the year, the MSCI World has lost 23% and the Nasdaq has decreased by more than 30%. Back home, thanks to the spike in commodity prices things looked better, but you were still not spared from losses – the JSE All Share Index has lost 11% since the beginning of the year.

Suffering losses is never easy. Seeing one’s portfolio decline by more than 20% in six months is enough to sound the alarm and run for the hills. It is in our nature to avoid danger and painful situations and Daniel Kahneman, author of Thinking fast and slow, argues that the pain we experience from losses is far greater than the joy we experience from gains. Hence, when we go through a sell-off in markets, especially the current one, we want to stop the pain: we want to protect what we still have and stop the bleeding.

When we place more weight on current information and expect trends to continue, it is referred to as recency bias. This behaviour causes a person to shift away from their long-term financial plan in return for comfort in very uncertain times. The certainty we seek usually comes with short-term comfort but is very expensive in the long term. A very common phrase used by individuals who go through a sell-off is, “I’ll invest in the markets again when there is more certainty”. Unfortunately, there is no siren that goes off to indicate that there is now certainty in markets. When the media starts reporting on a recovery in markets, the returns have already been made.

Here is a practical example from the most recent sell-off in 2020.

The bottom of the sell-off was on March 23 2020. On March 24, with increasing concerns that a vaccine is going to take longer than expected and that we are going to be locked down for the foreseeable future, the market started to rebound:

Date Daily Return of the S&P 500 Index
2020/03/23 -2.93%
2020/03/24 9.38%
2020/03/25 1.15%
2020/03/26 6.24%

Source: IRESS

If you decided to move your assets to cash on March 22, you would’ve missed out on a 16% rebound in just three days. Pfizer announced that they had a vaccine with 95% efficacy against Covid-19 only in November 2020. If you decided to shift back into markets at this point here are the monthly returns that you missed:

Date Monthly Return of the S&P 500 Index
2020/04/30 12.68%
2020/05/31 4.53%
2020/06/30 1.84%
2020/07/31 5.51%
2020/08/31 7.01%
2020/09/30 -3.92%
2020/10/31 -2.77%
2020/11/30 10.75%

Source: IRESS

Markets go through times where they can be extremely volatile and it may seem as if there is no light at the end of the tunnel. It is even more difficult to try and time the market, there is never a clear indication of when markets are going to turn and it may feel as if the current pain will last longer than we can handle. When markets finally start to rebound or turn, the uncertainty remains, plenty of market commentators will still say, “there is more pain to come” or, “it’s only a dead cat bounce” and it will still feed our fears of more pain and we don’t feel confident to invest again. Yet, if we remain on the sidelines because we seek comfort, we miss out on opportunities. As can be seen in the graph below, the market had fully recovered in August 2020, three months before Pfizer made their vaccine efficacy announcement:

Source: I-Graph

Here is another example. The financial crisis of 2008 also took markets by storm, and we had continuous declines for eight months from May 2008 to March 2009. Unlike the Covid-19 example above, the good news came before the market turned. President Barack Obama signed the Recovery Act into law in February 2009, however, markets only reached a bottom in March, a month later. The subsequent daily returns after the bottom were as follows:

Date S&P 500 Index daily returns
2009/03/10 6.37%
2009/03/11 0.24%
2009/03/12 4.07%
2009/03/13 0.77%

Source: IRESS

Bank of America researched the long-term impact of missing the 10 best trading days each decade and the results are staggering:

Source: CNBC

The bank concluded that if an investor missed the 10 best trading days each decade since 1930, the total return would be equal to 28%. On the other hand, if the investor held their investments through the market cycles their return would be 17 715%.

Our craving for certainty in uncertain times can make us feel better for a short time. Unfortunately, it comes at a very expensive price, missing a few days or even months can be the difference between a portfolio that delivered returns that are above inflation or not. It could be the difference between achieving your long-term financial goals or not.

Cash in the long term will not provide a sufficient return to beat inflation and for every year one is invested in cash, you actually lose purchasing power. If you pair this with returns that you missed out on because you succumbed to market fears, the price for certainty suddenly becomes much more expensive. Every individual has different circumstances and different financial goals. It is much easier for a 35-year-old to ride out a crisis than it is for a retired individual at the age of 70.

The important takeaway from the above is to make sure that you stick to your long-term plan and not make decisions based on short-term news and fears which can impact your long-term wealth creation ability. Benjamin Graham, the writer of The Intelligent Investor, wrote:

“The intelligent investor realizes that stocks become more risky, not less, as their prices rise—and less risky, not more, as their prices fall. The intelligent investor dreads a bull market, since it makes stocks more costly to buy. And conversely (so long as you keep enough cash on hand to meet your spending needs), you should welcome a bear market, since it puts stocks back on sale.”

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Abrie Grobler

PSG Wealth Pretoria-East

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The moral of the story is to invest long term expecting a healthy dividend and not selling – push through the pain, so to speak. Unfortunately Naspers changed all that, concentrating on short term spikes in the share price to drive the JSE into a short term buying spree – not a dividend insight…until it was too late!

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