Volatility can often spark our 'fight or flight' instinct from investors. Photo / AP
Volatility can often spark our 'fight or flight' instinct from investors. Photo / AP
Opinion
OPINION:
Markets have been a whole new ball game for investors over the past two years. When Covid-19 first emerged, we saw extreme volatility around equities and other financial assets.
This has eased as markets – and investors - have built up relative expectations around global public health responses andextraordinary financial support worldwide from central bank and governments. Still, the emotional toll of market ups and downs can be major.
As we're seeing from the easing of mobility restrictions around the world, there are likely to be bumps along the way to a post-pandemic world.
Volatility can often spark our 'fight or flight' instinct, or alternatively investors might avoid any risk altogether – with both scenarios potentially harming the likelihood of achieving long term investment goals.
Having an awareness around some of our potential reactions to market events, or behavioural biases, could help investors address them whenever they arise.
1. Define your investment timeline and goals - use this to frame decisions
The length of time you plan to hold your investments is important, because the approach you take when investing for the long-term is likely to be different to that over a shorter period.
In general, a longer timeline means an investor has greater capacity to take on risk, with the ability to withstand short-term drops in value.
Of course, situations can differ depending on an investor's unique risk tolerance, investment goals and needs, which are important for investors to clarify.
This allows a plan to be created - for a well-constructed, diversified portfolio - which would usually contain a mix of asset classes with different levels of investment return risk.
This is where the importance of an investment timeline comes in. While losses may be painful, an investor rushing out of the equity market after a fall may miss out on the potential gain as conditions change.
Looking at the US equity market daily returns (excluding dividends) from 1927 to 2021, an investor who stayed in the market for all days would have made a 6.1 per cent capital gain (per annum), while those who missed the 25 best days made only 3.5 per cent.
2. Keep emotions out of the equation
Diversification is about striking the right balance, but sometimes the vivid pain of a loss can cause investors to swing into action to prevent another drop, even though this may not come to pass.
This may lead investors to disproportionately pull away from a certain sector or stock. The emotional effect of losses on investors is known to outweigh that of gains.
This point is especially apt in relation to some major sector declines over the pandemic.
With the travel, tourism, and entertainment sector having faced major challenges, numerous airlines and travel groups saw even larger declines in 2021 with continued volatility around the easing of Covid restrictions globally.
Ongoing outbreaks also prompted the resumption of some mobility restrictions. However, as pandemic limitations ease and travel resumes, investors who pulled out of these stocks will not benefit from any of the potential longer-term uplifts.
3. Resist the fear of missing out
It feels good to join in, and there is a strong argument that with so much information out there, it's human nature to follow what appears to be the consensus. However, when investing, it can be better to actively question the crowds.
If a market rally is driven by the instinct of a large group, a downturn can happen as easily.
GameStop was one of the most notable examples of this in 2021, with a social media-driven rally driving the stock's price between a high of US$483 and a low of US$12.14 across a 52-week period. The price rose as everyone rushed to be involved, and it fell just as quickly when those investors hastily sold their shares once the sentiment turned.
Social media drove a rally in GameStop's share price in 2021. Photo / AP
As always, it's important to resist investor FOMO ('fear of missing out'), and make decisions based on quality information through independent research and/or financial advice.
At the end of the day, while some equities may draw more attention than others, spreading investments across a variety of different sectors and asset classes diversifies a portfolio and reduces risk.
It is the overall portfolio return which determines whether you achieve your investment objectives.
4. Instead of looking back, focus on what's ahead
When analysing potential investments, past performance can become a distraction. An investor might be tempted by a track record of price appreciation or deterred by recent declines – it is common to assume a similar occurrence in the year ahead. However, this expectation often does not come to fruition.
Take the automotive industry for example, where most major manufacturers agree that the future will be electric. The frontrunner on electric vehicles (EVs) to date has been Tesla, seeing more than 55 per cent growth in its share price during 2021. However, competitors like Volkswagen Group are growing their EV production at-pace.
While both Tesla's brand and battery power is strong, current supply chain issues are impacting its ability to efficiently turnaround product, exacerbated by its business model of in-house manufacturing. The more traditional auto brands, now ramping up electrification, are well versed in scaling and outsourcing.
Increasing EV incentives around the world may see more demand for these vehicles among mass market consumers, potentially creating more opportunities for those manufacturers that can provide more accessible price points.
Another example can be found in healthcare companies, with many (such as Fisher & Paykel Healthcare) experiencing significant growth globally through the pandemic. However, as vaccination rates increase around the world and hospitalisations decrease, they may experience a gradual period of 'normalisation'. While the past can help us understand what may happen in the future, 'history doesn't repeat itself, but it often rhymes'.
Recognising the potential tricks of the mind, when it comes to investment, can help investors stay grounded within their original objectives. Occasional changes to a portfolio - aligned with investment goals - can be beneficial. However, chasing expected winners can carry a greater risk of not meeting your aims, as well as creating high levels of stress.
As investors head into the new year, and think about altering their investment portfolio, they should ask themselves, "Have my investment objectives really changed? Are my current investment objectives no longer suitable? Or am I reacting out of instinct?" Sometimes the best course of action is to stay the course.
- Chris Wilson is director, head of wealth solutions and John Norling is director, head of wealth research at Jarden.
