Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 320

How to be a human be-ing, not a human do-ing

We are so busy in our lives today. Decisions are made instantaneously, but knee-jerk reactions are often the wrong course of action. Taking the time to evaluate a situation can lead to a more informed decision and a better result in the long term. We are human be-ings not human do-ings; we don’t always need to be active and taking immediate action.

Quick decisions are often made because of fear. We are scared of failing or losing control. Switching away from a poorly-performing investment is a case in point, as it is human instinct to not want to suffer through poor performance.

It is very difficult to not look at short-term investment returns. During these periods many investors may be tempted to take swift action and switch out of a poorly-performing fund into a fund that has performed better. Although this may appear to be a sensible way to generate better returns, switching funds during periods of poor performance can destroy the value of your investment.

In order to switch, you have to sell your units, which will usually incur ‘friction costs’ (all the direct and indirect costs associated with a financial transaction, such as transaction fees and taxes). It also locks in the underperformance of the fund that you are switching from. At the same time, there are no guarantees that the fund that you switch into will be able to repeat its recent strong performance. By switching you are often selling and buying at exactly the wrong time.

Managing the urge to switch

There are many reasons why we switch. Next time, before we do it, it is worthwhile considering the following three factors to judge how much of a role they play in the decision making.

1. Our emotions. Market volatility is part of investing and unfortunately so is underperformance. You would not be human if this doesn’t create a sense of fear, or at least make you uncomfortable. These emotions often lead to taking action that will permanently lock in losses or missing the best time to invest.

Your role as an investor is to pick an investment such as a managed fund on the basis that it suits your needs and objectives and that you trust the fund manager – not solely on account of recent performance. If you can control your emotions, and hold on to that investment through the volatility, you have a better chance of achieving your objectives over the long term.

2. Forecasting. Driven by heavy doses of market commentary, investors often turn to macroeconomic factors to determine whether markets will deliver strong returns. However, various studies have shown there is no correlation between economic growth and share returns.

Using data from 46 countries, researchers from investment managers Vanguard found that the average equity market return over the long term of the countries with the three highest gross domestic product (GDP) growth rates was 4%. This was slightly below the average return (4.2%) of the countries with the three lowest GDP rates, despite a considerable difference between those GDP rates (8% a year versus 1.6%).

In the end, what determines the success of your investment is the price that you pay for an asset and how much return it generates for you.

3. ‘Black Swan’ events. In his 2007 book, The Black Swan, risk analyst Nassim Nicholas Taleb revived a metaphor first used by Roman poets. ‘Black swans’ are incredibly rare events that are difficult to predict and can have a major effect on markets and investments. Examples include natural disasters, or the September 11 attacks, and most recently, Brexit.

The impact on your portfolio from Black Swan events can be significant. They are highly unpredictable, however, and it is not a good idea to base your investment decisions on what could ‘possibly’ happen.

To benefit when switching funds, you have to be able to choose the best times to leave and enter the market. This is nearly impossible because markets can swing wildly from day to day in response to a variety of unpredictable factors.

Best action may be no action

Remaining invested when faced with poor performance will take strong nerves. But if you can steady your emotions and keep in mind the reasons why you invested in the first place, you can ride out a difficult period and hopefully enjoy good returns in the future. It would have been tempting to switch your investments in the final quarter of 2018 after a period of poor performance, but the S&P/ASX 300 Index was up almost 20% in the following six months.

Sometimes there are good reasons to switch. For example, if your objectives, or the fund’s objectives, change then your investment may no longer be suitable. You may have lost faith in the fund manager, or maybe you simply need to rebalance your portfolio.

Before making any decision, investing or otherwise, it is important to slow down, take time to re-evaluate the situation and focus on your long-term priorities. In today’s world the urge to take immediate action can be overwhelming, but sometimes the best course of action is to do nothing at all.

 

Julian Morrison is an Investment Specialist at Allan Gray Australia. This report constitutes general advice only and not personal financial or investment advice. It does not take into account the specific investment objectives, financial situation or individual needs of any particular person.

 

3 Comments
Allan Gray Australia
September 04, 2019

Steve, SMSF Trustee, thank you very much for your comments. In response to the comment from SMSF Trustee…

It is always a challenge to cover complex topics in a brief article and it does leave open the potential for ambiguity. The point you make around risk is sensible and important to address.

We certainly do try to think about all possible outcomes, even if they are considered unlikely. In particular those that are on the negative outcome side of the ledger – we do obsess about the downside. Our main point in the brief section on black swan events was that we do not make such events a central part of an investment thesis. We do however focus on the potential downside to each investment we make, including unlikely outcomes, and think about risk. Perhaps the most obvious way that is addressed for positions we hold is the management of position size.

On the specific point on AMP, it is debatable whether that should be referred to as a ‘Black Swan event’. In any case, this is an example of where we have built our position gradually, and managed the overall size to a level we deem appropriate given our assessment of potential risk, and potential return. Something we undertake carefully with every investment we make.

This is the type of subject where we could go into great detail and we would enjoy the opportunity to discuss it with you further, if you like. We don’t have your contact details but if you would like to call us on 02 8224 8600 we would be more than happy to chat.

Steve Darke
August 22, 2019

I don't think you can classify AMP as a black swan event. It has been a dud company for many years and obviously so. Contrarian investors might see some value there, but that's what defines them as contrarian. The article correctly states that portfolio construction shouldn't take into account black swan events, given their inherent unpredictability. How you prepare for something that no-one is able to predict?

SMSF Trustee
August 22, 2019

As an investor in Allan Gray, I really hope that they manage tail risk better than the article suggests, in the discussion of Black Swan events.

If an outcome is only "possible" and has small consequences if it becomes reality, then it's safe to ignore it in the investment strategy.
But if a possible outcome would have severe consequences, "possibly" wiping out a chunk of your capital, then it can't be ignored.

It's one thing to be a high conviction and contrarian stock picker like Allan Gray. It's quite another to manage investment risk recklessly. I'd appreciate a follow up comment by Julian to expand on his comments, especially in light of Allan Gray's investment in AMP which seems to have been an outworking of this 'don't worry about what's only possible' approach and is the reason they've underperformed badly recently.

 

Leave a Comment:

     
banner

Most viewed in recent weeks

Three steps to planning your spending in retirement

What happens when a superannuation expert sets up his own retirement portfolio using decades of knowledge? He finds he can afford much more investment risk in his portfolio than conventional thinking suggests.

Finding sustainable dividend stocks on the ASX

There is a small universe of companies on the ASX which are reliable dividend payers over five years, are fairly valued and are classified as ‘negligible’ or ‘low’ on both ESG risk and carbon risk.

Retirement income promise relies on spending capital

The Government has taken the next step towards encouraging retirees to live off their capital, and from 1 July 2022 will require super funds - even SMSFs - to address retirement income and protect longevity risk.

Among key trends in Australian banks, one factor stands out

The Big Four banks look similar but they are at fundamentally different stages as they move to simpler business models. Amid challenges from operating systems, loan growth and neobank threats, one factor stands tall.

Why mega-tech growth are the best ‘value’ stocks in the market

They are six of the greatest businesses ever and should form part of the global portfolios of all investors. The market sees risk in inflation and valuations but the companies are positioned for outstanding growth.

How inflation impacts different types of investments

A comprehensive study of the impact of inflation on returns from different assets over the past 120 years. The high returns in recent years are due to low inflation and falling rates but this ‘sweet spot’ is ending.

Latest Updates

Superannuation

Retirement income promise relies on spending capital

The Government has taken the next step towards encouraging retirees to live off their capital, and from 1 July 2022 will require super funds - even SMSFs - to address retirement income and protect longevity risk.

Superannuation

How retirees might find a retirement solution in future

Superannuation funds need to establish a framework that offers retirees a retirement income solution that lasts a lifetime. It will challenge trustees to find a way to engage that their members understand and trust.

Investment strategies

Dividend investors, your turn is coming

Dividend payments from listed companies, depended on by many in retirement, have lagged the rebound in share prices over the past year. Better times are ahead but sources of dividends will differ from previous years.

Investment strategies

Four tips to catch the next 10-bagger in early-stage growth

Small cap investors face less mature companies with zero profit that need significant capital for growth. Without years of financial data to rely on, investors must employ creative ways to value companies.

Investment strategies

Investing in Japan: ready for an Olympic revival?

All eyes are on Japan and the opportunity to win for competing athletes. After disappointing investors for many years, Japan is also in focus for its value, diversification and the safe haven status of its currency.

Fixed interest

Five lessons for bond investors from the Virgin collapse

The collapse of Virgin Australia not only hit shareholders, but their bond investors received between 9 and 13 cents in the $1. A widely-diversified portfolio can tolerate losses better than a concentrated one.

Investment strategies

The 60:40 portfolio ... if no longer appropriate, then what is?

The traditional 60/40 portfolio might deliver only 1.5% above inflation in future without diversification benefits. Knowing an asset’s attributes rather than arbitrary definitions is better for investors.

Retirement

Two factors that can transform retirement investing

Retirees want better returns but they have limited appetite to dial up their risk exposure in order to achieve it. Financial advice and protection strategies in portfolios can enhance investment outcomes.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.