Fear can take hold of even the most rational investor.
Investing is a rollercoaster ride.
The most enjoyable part of the journey is the bit up (when everything is going well). In these periods when it appears easy to make money, investors can become complacent believing what that has happened in the past will continue to be so for the future.
The reality is that at some point what goes up can and likely will come down. This can be subtle or sudden but the danger is that when this happens, it becomes hard to remember the reasons why it was right to invest in the first place.
Fear can take hold of even the most rational investor.
As the markets fall panic ensues and what seemed right now appears wrong. Investors can make decisions that they would never have made before.
In 2008 as markets tumbled it would have been easy to pull all investments out of the market, but timing when to get back in (and recover the losses) is probably the hardest bit (especially when markets fell again in 2011 and 2013).
The truth is that nobody has yet shown that they can correctly and consistently time markets.
The reverse is also true when the markets keep going up it is easy for investors to think they are geniuses. The rational investor becomes irrational making decisions which they would never have made before because they think they will get it right again.
This mentality is no different to dogs chasing their tails. An investor can go round and round, exerting energy and achieving nothing.
Consistently timing markets
Every market cycle has both up and down days; consistently predicting which days will move in which direction is virtually impossible and can be costly.
For example, £100,000 invested in the FTSE All-Share Index between 1993 and 2012 would have returned £445,804 for an investor.
However, if at any point they took out their money and missed five of the top-performing days the return would drop to £306,704. Missing 25 days the return would be £132,279.
There will be those who claim they can time the market but the even the greatest investors will say this is impossible.
Paying an adviser
There is a growing argument that paying an adviser a fee is worthless, because if no one can time the market then why pay someone to do it.
With the growth of low cost investment options surely it is cheaper and easier for an investor to go it alone.
The view is that when it comes to investing all an adviser does is put together a portfolio of assets on the basis that they believe they can time and therefore beat the market.
This is one of the greatest misunderstandings of what advisers do.
One article I read said that if you are paying to put someone between you and stupid, it’s worth every penny.
This seems harsh but the reality is that it provides a truism to what advisers are doing.
Every adviser will approach this differently but there are two cornerstones to portfolio building.
Firstly it is not about trying to time the market and it is not about identifying the next big investment opportunity.
The process of building a portfolio and running a portfolio applies when things are going well and badly. It is not only about identifying the best managers and outperforming a basket of index tracking funds but a lot more.
It’s relatively easy for an individual to select and build a portfolio of assets. However, the difficulty is sticking with that path; investors who put their money in the best place often don’t leave it there. Perceived success, or failure, makes many investors lose sight of what they believed to be right.
The portfolio will act as the steady ship in times of market exuberance and decline. It is not about chasing the tail to find the next big thing, it is a dull, boring but sensible “get rich slowly strategy.”
It is about responding to investors’ needs and acting as the middle piece to stop irrational or knee jerk behaviour (which we are all guilty of)! As an example in 2011 when the markets tumbled many investors remembering 2008 panicked and cashed in their investments, crystallising losses. The challenge was when to go back in to make up those losses. Many of those investors probably timed it wrong and have not made up their losses.
History shows that holding a steady approach might give short term pain but will deliver long term gain. Managing a portfolio is that rational head but it goes further.
Investors will hold onto winners on the basis that they will only go one way. Investments will only go one way up to the point that they don’t! Disciplined management of portfolios will see rebalancing of assets perhaps once a year at a set point to sell down the winners and buy the losers. By doing this it takes out the guess work of which asset or region will perform best.
In summary portfolios are rational steady ships which ignore what is happening around them.
Trying to time the market is impossible.
Staying out of the market even for a short period of time is proven to be costly. Investors can make their own decisions but the challenge for them is two-fold; firstly having a plan and secondly sticking to that plan. It is very easy to stick to the plan when things are going well but it is much harder to do it when life takes a turn.
Paying an adviser 1% p.a. may seem costly but if it acts as a barrier between the investor and irrational or knee jerk behaviour then surely it is worth every penny. An adviser offers a multitude of benefits and it is not about timing the market, it is about being the rational head when everything else seems irrational, and therefore can be a valuable investment.
NOTE: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.