Fast little loans
This article was first published in the first-quarter 2012 edition of Personal Finance magazine.
Most retirement fund members sat out the latest turmoil in the financial markets, as well as other recent investment firestorms, emerging with far better results than most of the members who switched between investments in a vain attempt to beat the markets.
This is one of the findings of research by the country's largest retirement fund administrator, Alexander Forbes, which tracked the investment behaviour of more than 700 000 retirement fund members over a three-year period to August 31, 2011.
Overall, there were 27 138 transactions, of which 8 934 were found to be active investment choice switches by 6 768 members. About 17 percent of these members switched more than once in this period and about 5.3 percent of them switched at least three times during the three-year period, on average.
There were 53 members who switched at least six times over the three years – mostly to their detriment (see the "Investor behaviour" case studies; link at the end of this article).
The analysis also revealed that the vast majority of retirement fund members simply rely on the default investment options provided by fund trustees.
John Anderson, the national head of consulting strategy at Alexander Forbes, says the research shows that in times of volatility, the obvious answer for retirement fund members "is to ignore what markets are doing".
This is, in fact, what most members do. More than 85 percent of retirement fund members rely on the investment portfolio decisions made by their fund trustees, who create default portfolios into which members' savings are automatically channelled.
This reduces the risk that a member will make incorrect investment decisions, such as trying to time market movements when the markets are volatile.
However, Anderson warns that in designing default options it is "critically important" for your trustees to ensure the options are appropriate for the membership profile of your fund.
He says it is equally important for trustees to provide members with the necessary tools, through both education and advice, to ensure that you make the right investment decisions for the right reasons.
Anderson says there are legitimate reasons for switching investment portfolios, but trying to avoid short-term volatility is not one of them.
He says the only retirement fund members who should consider adjusting their investment portfolios are those who are within five to 10 years of retirement. They should gradually reduce the risk in their portfolios as they approach retirement.
Anderson says in the years immediately that before retirement you should also start to align your pre-retirement investment portfolio/strategy with your post-retirement investment vehicle (type of pension).
"This decision is not based on the current market level but on the pension requirements of a member," he says.
Anderson says it is very important that you obtain financial advice at the pre-retirement stage to ensure that the investment strategy matches your needs.
If you are more than five or 10 years from retirement, you should not be concerned about short-term movements in investment markets, he says.
"Markets will fluctuate, but unless you actually need to disinvest the money, which you should not do, it does not really matter.
"In fact, a drop in the market means you can buy more shares for the same amount of money."
The Alexander Forbes research showed that, among other things:
* A sharp drop in investment markets is usually followed by an increase in the number of fund members who reduce the risk to their investments.
* After the market recovery from March 2009 to May 2011, members gradually started to increase their exposure to risk again.
* Most members who reduced the risk to their investment portfolios when the financial crisis started in 2008 have not yet switched backed to a higher-risk portfolio (with the result that they have missed out on the market recovery).
* Switching generally takes place after market movements have occurred, with the result that members are "either too late in protecting their portfolio or too late in getting back into the market".
The research shows that the extent of switching is more pronounced once markets have fallen than when markets recover.
Anderson says this indicates that members find it easy to reduce risk in their retirement portfolios when markets have fallen or are falling. But members find it much more difficult to decide when to reinvest in the markets.
This, in turn, shows that members are generally risk-averse and that negative returns have a greater impact on their behaviour than positive returns – something borne out by behavioural finance theories.
"The combination of actions can have a significant impact on a member's long-term financial security," he says.
* The number of switches increases with age. This suggests that, as people get closer to retirement and become more aware of their needs, they more actively engage in switching, Anderson says.
* Female retirement fund members tended to be more cautious than male members during market downturns, whereas behaviour of men and women appears to be similar when the market recovers.
With the return of market volatility on the back of the Greek and Italian debt crises, other concerns about the eurozone and fears of a double-dip recession, there has been an increase in the number of investors reducing the risk in their investments, Anderson says.