It seems that we live in a time when outcomes are only good or bad, heads or tails, yes or no. This is what mathematicians call binary outcomes.
In the battle against state capture, the outcome for our country will either be great or terrible; it’s hard to see a middle-of-the-road scenario in the near future. Similarly, the credit ratings agencies will deliver their verdict on our economic future by the end of the year. A positive announcement will be well received by the markets, whereas people will probably panic if we are downgraded. How do investors make rational decisions in this binary world?
Few investors can consistently make money by following an investment strategy that is based on trying to predict the future. This is called market timing, and it is an expensive way to invest your capital. First, you must be able to predict the outcome accurately – for example, the verdict of the ratings agencies on economy, or whether the British electorate will vote to leave the European Union. Currently, the verdict of the ratings agencies might seem obvious, but then so was the Brexit vote and look what happened there.
Second, you must be able to predict how other investors will react to the news. Let’s consider the aftermath of the Brexit vote. Although the London stock market fell initially, it has been on a strong upward trend since and is more than 15 percent higher than it was 12 months ago.
If you decide to sell your shares in anticipation of a ratings downgrade, because you are concerned that the stock market will collapse, you might be making a huge mistake. The most recent comparable country to study is Brazil, which was downgraded in February, but has seen its stock market jump by nearly 40 percent since. It is higher than it was a year ago, so investors who sold in the months before the downgrade are really losing out.
Who can say what will happen to our market and the rand if we are downgraded? It would be foolish to assume that the impact on the market will be negative.
In these circumstances, where the outcome of potentially significant political and economic events is so uncertain, it does not make sense to be too specific in your investment planning; instead, you should aim to spread your risk as much as possible, to ensure that portions of your capital will rise even if events don’t pan out the way you thought they would.
This means you should diversify by investing in a range of asset classes, including cash, bonds, listed property and shares. If the downturn does not materialise and markets rise, your investments in shares and listed property will rise.
It also makes sense to diversify across different countries and currencies. If you have most of your assets in rands, you should consider increasing your allocation to foreign investments. However, you should do this carefully and not in one batch.
I am not too concerned about owning a range of offshore currencies. If you buy a unit trust fund that invests in a portfolio of global investments, it will be denominated in a particular currency – for example, United States dollars – but this does not mean that the entire portfolio will be invested in the US; it will also be exposed to European, Japanese and other investments.
When you are investing at a time of market volatility, when the price can move dramatically within a few days, it makes sense to spread out the purchase (phase it in) over time, to mitigate your losses if you buy just before a major fall in the price. Starting a new investment and then immediately losing value can set you back a number of years. I buy foreign exchange in batches – preferably, at least three batches over a number of months.
Banks generally charge higher fees on foreign exchange transactions when you transact in smaller amounts, so you should aim to make the amounts as large as possible.
Don’t be too concerned about making major changes to your investments when political and economic events become media sensations; the hype is never good for rational investor behaviour. - IOL
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