Election year is a notoriously tricky time for investors, as uncertainty and risk prevail.
Forecasting is extremely tough in an environment where both risk and uncertainty are present because we’re trying to predict within a complex system with multiple possible interactions and outcomes.
According to Paul Nixon, head of behavioural finance at Momentum Investments, there is a difference between risk – where we know all the probabilities – and uncertainty, where we don’t.
At a roulette table, we know that betting on black or red gives us a 50% chance of being right and the possibilities are finite – the ball must land on a red or black tile.
The problem here is that humans are rather terrible at dealing with risk in calculating probabilities particularly when they get trickier, like when buying a stock.
Nixon maintains that humans tend to overweight or underweight probabilities where they are close to 0% probability or 100% probability, citing a fascinating study where people were willing to pay a sum of money to improve the odds of a successful serious operation from 89% to 90%, but were unwilling to pay the same for improving the odds from 42% to 43%, for example.
Uncertainty is even more slippery as we don’t know the probabilities. Possible outside interference in an election is a good example of uncertainty.
In recent times, we’ve seen massive fines being dealt to social media platforms that influenced elections.
Of course, there was the allegation of outside interference in the election that saw Donald Trump first elected – something no one predicted given that all the polls indicated that Hillary Clinton would win.
This also provides other insights into human behaviour: people don’t always do what they say they will.
As a financial adviser, I tell my clients that the upcoming elections contain both risk (probability of various outcomes materialising) as well as uncertainty (unpredictable events happening). All of these will have market implications, and thus also impact our finances.
However, it is important to bear in mind that these are risks and uncertainties globally and present in any election, whether in the US or South Africa.
The inevitable doomsday machine narratives from some quarters ensue because extreme views get media attention. Be careful of making investment decisions under the influence of these narratives.
My role is to help my clients separate emotions from their decision-making process, making them aware of some of the most common mistakes investors make.
These include:
Attribution bias
A recent example relates to the value of the rand as the ultimate barometer of South Africa’s “share price”. The weakening rand of late has likely been attributed to our more volatile political climate which makes us all more uneasy and more uncertain.
In fact, the weakening rand is likely weaker because of the strength of the dollar – in other words, because the US has for the first time since quantitative easing operated in a high inflation and interest rate environment and is attracting investors away from emerging economies.
In South Africa, we are inclined to attribute all negative news to the “failed state” narrative which is simply not true.
Echo chambers
Social media algorithms are designed to surface things you like or agree with. This quickly gives us the sense that the world is more predictable than it really is, which usually gives us overconfidence.
A quick way to see if you’re in an echo chamber is to look at the people agreeing with you or liking your posts. If they all look like you, you’re probably in an echo chamber. Seek diversity in views.
Concentrated positions
One of the best ways of dealing with risk and uncertainty is avoiding concentrated positions, and ensuring your investments are well diversified.
Knee-jerk reactions
Don’t elicit a stress response that could catalyse a bad decision by overly exposing yourself to negative information around the election or doomsday prophecies. Again, the most sensible approach will likely be a balanced one.
As a financial adviser, I need to discuss all risks and uncertainties with my clients and plan for them.
I advise people to have a short-term plan (one to three years), a medium-term plan (three to seven years) and a long-term plan (seven to 15 years), while saving diligently for retirement through these time horizons.
Make sure to review these plans regularly when short-term risks and uncertainties such as elections arise, so you are financially prepared for the best and worst-case scenarios – and remember that the highest probability is that the base case scenario will play out.
The same would apply to medium-term financial plans, which may include starting a monthly investment plan and sticking to it so that you can double or triple your investment capital during this time horizon, and a long-term plan that takes into account the effects of inflation and currency devaluation.
Whether you are a conservative investor and prefer to only earn interest or are an aggressive investor and want to invest in the stock market, make sure you do your own research in consultation with your financial adviser and study the global market.
This is important so that you don’t suffer from concentration risk and invest in only one market, be it the Johannesburg Stock Exchange or the New York Stock Exchange.
It is important to remember that the world is full of risks and uncertainties and always will be.
However, if you start building a nest egg at an earlier age and are faced with an unforeseen event such as another pandemic, retrenchment or even an election, then it is far easier to plan for different outcomes and manage them effectively because you have a diversified and well-established asset base that gives you more options.
In conclusion, know that humans are wired to fear the unknown.
Your financial adviser plays a vital role in managing and securing better investment outcomes by helping you navigate risk and uncertainty and making better and more rational decisions.
*Jurgen Eckmann is wealth manager at Consult by Momentum.
**The views expressed here are not necessarily those of IOL or title sites.
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