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Why investing is much harder in practice than in theory

By Time of article published Jul 22, 2021

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By Anet Ahern

The first half of 2021 is already behind us, and it seems clear that this year will be another challenging one for investors. Had someone told you in January that the JSE would be 13.20% higher halfway into the year, you may have struggled to believe it.

But here we are - the market is up by just over 78% since having reached its low in March 2020.

On 19 March last year, investors had no way of knowing that markets had reached a significant low. While it is easy to focus on the spectacular market recovery with the benefit of hindsight, it is worth reflecting on the conditions investors were faced with at the time.

A flashback to March 2020

Business confidence in South Africa was at its lowest level in 21 years, doctors across the world were struggling with PPE shortages, and trials of a Covid-19 vaccines were only starting. The Bank of England had just cut its interest rate to an all-time low of 0.1% and Donald Trump was still the US President, with Joe Biden yet to be confirmed as the preferred Democratic Party Candidate.

Locally, the South African Reserve Bank dropped its repo rate by a full percentage point, although the country would only reach its record low repo rate of 3.5 % about three months later. The rand was on a precipitous slide against the dollar and South Africa’s first day of stay-at-home lockdown orders would only take effect on 27 March 2020. The crypto currency frenzy was still to come.

Rand vs. US dollar

Supplied

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The difference between theory and practice

With the benefit of hindsight, March 2020 was a great time to invest. However, for investors caught up in the emotion and uncertainty of the time, making the decision to remain invested (or even better, invest more) would have been far from straight forward.

While it is easy to disregard emotions in hindsight looking at investments from a purely theoretical perspective, it is very difficult to do so in practice. In the heat of the moment investors have to make decisions faced by paralysing uncertainty. Those who disinvested at the bottom of the market, are probably regretting their investment decisions now, with the benefit of hindsight.

In addition, it is hard to take our learnings from the past in the future and apply them in a new environment. For example, faced with similar levels of uncertainty now, we will still struggle to think back to times of equal uncertainty and use these insights to our benefit.

How investors can cope with uncertainty

Understanding that market conditions are temporary and subject to change (both good and bad), may be the investor’s best protection. It is this knowledge that can help us tame both fear and greed (the twin enemies of investors everywhere), by forcing us to take a longer-term perspective.

This approach also helps to cement the importance of diversification as an investment strategy. Once the inbred variability in the market is understood, investors are much less likely to fixate on one single approach as a ‘silver bullet’ to wealth creation, and far more likely to spread investments widely.

Thorough research and a tried and tested process

The combination of a defined process, structure and as much objectivity as is realistically possible, is powerful in preventing behavioural pitfalls in investing. This applies equally to the process of advising clients. While it’s important to acknowledge the emotions embedded in investing, it’s even more important to apply structure and objectivity as a safeguard against kneejerk actions, which can damage a long-term investment plan in profound ways.

Markets are variable, and we plan accordingly. By buying great companies below their intrinsic value, and having the patience to wait for the market to appreciate their true value in time, we believe we are best positioned to build wealth for our clients in the long run. Sometimes it takes time for this strategy to unfold, but for the patient and objective investor, the rewards are significant.

Anet Ahern is the CEO at PSG Asset Management

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