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The best post-crisis advice
If there is one thing with which financial intermediaries can assist their clients, it is to encourage them to learn from history, writes Marize Pieters.
As recently as May 2008, we witnessed another stock market crash, the second one in a single decade and one of the most severe ever.
Markets were once again characterised by exuberant buying, irrespective of what the fundamentals said, which led to prices reaching exceptionally high levels.
When this occurs, markets often overshoot their intrinsic fair value, as market participants are afraid they will be left behind. Instead, they choose to rather go along with the herd, driven by fear and greed.
History has often taught us that at these unprecedented high levels, stock markets will eventually lose steam, resulting in a total collapse in stock prices. As investors lose complete faith, their irrationality causes the market to undershoot its fair value.
However, post-crisis lessons have taught us that markets tend to recover quite quickly from these depressed levels.
The table opposite is an example specific to South Africa, but the same phenomenon is evident all over the world. Once markets bottom out, investors are rewarded quite quickly with extremely good returns on their investments in the months that follow.
However, the major challenge is that it is not always possible to know with certainty when markets have bottomed out.
How did our investors react to the latest crisis?
According to the latest statistics from the Association for Savings & Investment South Africa, a small portion of investors (in the retail market) has recently moved out of cash and back into the equity market.
In essence, it took them close to a year to regain confidence in the market and there is still a large group waiting on the sidelines for more clarity as to its direction.
This means that the bulk of investors have unfortunately missed out on the recent recovery in the South African
stock market.
A contributing factor to this common phenomenon is that human emotions play a very prominent role when it comes to investing, and investors are often unaware of this.
It so often causes investors to go against good investment practice. In times of market uncertainty, investors often act irrationally, losing sight of their long-term financial goals. They allow the most recent historic events to dictate their behaviour.
In turn, they buy when prices are high out of fear of missing the boom market, and sell low out of fear of losing money in a bear market – instead of the converse of selling high and buying low.
To make matters worse, once their money is out of the market and back in the bank, they more often than not wait too long to get back into the market. This emotive short-term investment focus is a sure way to destroy value.
Investing is not a short-term game nor is it one of timing the market perfectly. It involves having a solid financial plan with set goals that are focused on the medium- to long term.
This is exactly where a credible financial intermediary plays a critical role. An invaluable intermediary is someone who not only advises the client, but structures an investment plan with which he/she is comfortable.
More importantly, the intermediary should be able to protect the client against his own investment imperfections.
A relationship between intermediary and investor should be a long-term partnership and one of mutual trust.
Once investors become more aware of the reasons for and consequences of irrational investment behaviour, they will be in a position to make wiser investment decisions and be one step closer to becoming a more successful investor.
As economist Warren Buffett once said, “Be fearful when others are greedy, and greedy only when others are fearful”.
