Four quick investment lessons

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Given the recent market events, such as the weakening Rand, it is becoming even more vital for investors to understand that their investment portfolios are not only influenced by market movements, but also by their own actions.

This is according to Dave Mohr, Chief Investment Strategist for Old Mutual Wealth, who points out four simple, yet very valuable, investment lessons from recent market developments.

He says that investors should be mindful of behavioural finance - the various cognitive biases that impact the way individuals invest. "One particular bias, called 'anchoring', results in people basing decisions on an 'anchor', which refers to the most recent event or frame of reference to which they hold value. This 'anchor' influences their decision and is used as logic to make judgement calls."

Mohr explains how an 'anchor' can affect investment behaviour. "The Rand has been somewhere above R11/US$ for a while and has become the anchor for many investors. When the Rand strengthened to around R10.70/US$, this may have seemed impressive, when in fact, the Rand has lost 60% of its value since August 2011, and even with the recent appreciation, is still very weak."

Another key aspect for investors to bear in mind is that markets don't move in a straight line, says Mohr. "Anyone who thought that a weakening Rand is a one-way bet has been wrong, at least for now. The Rand might weaken again, or strengthen further, but it won't happen in a straight line."

He says that this is a good thing for investors. "Zig-zag patterns or volatility create healthy two way expectations in markets. For instance, China's tightly-controlled currency appreciated in almost a straight line for years and investors thought it was a one way bet, positioning them for a continued appreciation. Then, when the Yuan recently endured a small fall, investors, especially leveraged speculators, who bet that the currency would continue to appreciate, suffered losses worth millions of Dollars."

Another lesson is that even growth investors can benefit from a capital protection focus. "A 50% fall followed by a 50% recovery doesn't get you back to where you were. The JSE Gold Mining Index lost 54% in 2013, and has gained 49% so far in 2014. However, the index is still more than 30% below where it was at the start of 2013.

"If you need exposure to growth, you can't avoid volatility, but diversification, rebalancing and a focus on valuations are simple ways of avoiding excessive volatility. But remember also that volatility is not the same as losing money - or permanently impairing your capital. With long-term investing, market volatility fades into the background, but if you buy something that is completely overvalued, you are unlikely to ever show a return. Japan's Nikkei was a top performing major equity index last year, but was still 60% below the peak recorded at the end of the 1989. At that point the Nikkei traded on hopelessly overvalued PE of 100. Similarly if you had bought the Microsoft share in January 2000 at $56, you will still be 30% in the red today. The initial price paid for an investment is crucial in avoiding a permanent loss of capital."

Lastly, Mohr advises that investors should focus less on the short term or daily news flow and more on the price or valuation of an asset. "Investors can easily get hung up on the 'doom and gloom' stories and worry how it will impact their portfolios, but that they forget that the bad news is typically already reflected in the price of the asset.

"If all the bad news is already factored into the price of the asset, only a little bit of good news can lead to a rally. Five years ago, in March 2009, the market was pricing in an almost total collapse of modern capitalism. Relative to that expectation, the smallest bit of good news - which arrived when then Federal Reserve Chair Ben Bernanke started talking about 'green shoots of recovery' - was enough to turn the tide. Since then then global equities have staged a phenomenal rally." concludes Mohr.

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