Curb the investment switch itch or face the consequences

By Paul Nixon, Head of Behavioural Finance at Momentum Investments

Paul Nixon

From a global pandemic to a supply chain crisis to a conflict in Europe, economic fluctuations seem to be the reality of the era. Investors need to avoid letting their emotions cut their investment journey short by unnecessarily switching their investments.

As investors, people tend to be driven by two emotions, fear and greed, though, we can’t deny how much our recent economic timelines have instilled a great deal of fear in investors across the globe.

These rising levels of uncertainty have pushed investors to seek more control of their savings. According to Momentum Investments’ latest Sci-Fi report, behavioural patterns of South African investors played a role in producing a record number of investment switches in 2021.

The report measured investor behavioural patterns on the Momentum Wealth platform for the 2021 period. By analysing the behaviour of over 16 000 investors during this period, it was found that active investors (defined as investors performing switch transactions) increased by 80% and the number of switches by 50% to a record-high level of 27 994.

On average, investors were chasing past performance and up risking their investment portfolios from October 2020 to April 2021. This reversed dramatically as the South African volatility index spiked and investors switched to worse performing funds down risking their investments. This resulted in an annualised behaviour tax of 3.5% for investors in 2021 amounting to over R90 million.

“It is clear we need to reign in our kneejerk reactions to macro-economic events. By understanding why investors decide to switch, we can then start designing better investment portfolios.”

While switching may seem like a reasonable decision to protect one’s return on investment, or even to generate even better returns, Nixon says switching funds during poor performance generally does more damage and inevitably destroys the value of an investment.

Frequent switching in large volumes can actually have a wide-ranging impact on the retirement system and economic growth as a whole. Zooming into an individual level, he says frequent switching will likely result in worse net investment performance, reducing the level of returns investors can ultimately receive.

In addition to this, switching can also add fees and taxes to the cost of investment. As switching involves the sale of an asset, the transaction could trigger capital gains tax, and the fund you are switching to may charge initial fees. There can be a lot of little fees, which, based on the frequency of switching, can really add up.

There are, of course, scenarios where switching is the ideal solution, but he says investors should consider all options first. As a golden or general rule of thumb to decide when switching is appropriate, consider this, if your investment goals haven’t changed then your investment strategy to reaching those goals shouldn’t be changing either.

If you feel like now is the time to switch, I advise you speak to your investment manager or a financial adviser to get a sense of the implications and opportunities. They could be more far-reaching than you realise. More often than now, however, switching is a bad idea and is only based on an emotional response.

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