By Anet Ahern, CEO, PSG Asset Management
The importance of human emotions in investment decision-making is firmly established. It is often said that the drivers of stock market returns are fear and greed, and this is especially true in the current environment. In fact, perhaps the best investment resolution you can make this year is to commit to managing the impact of your emotions better, so that they don’t impact negatively on your financial decisions. But for those looking for more practical guidance, here are five resolutions I believe will set you up for a better 2021.
I will remember that the future may look different to the past
When times are tough, people tend to think things will continue this way indefinitely. Being aware of this tendency and recognising it in yourself if it arises, may help to keep you focused on your long-term plan. One thing history tells us about the markets is that the good times don’t last forever – but neither do the bad ones. A key aspect we often overlook is that during tough times, good companies respond by becoming leaner and more efficient. Once demand returns to the market, the impact is really felt in the earnings recovery.
I will avoid the trap of buying ‘failsafe’ shares at any price
Margin of safety is the difference between a company’s prevailing market value (its share price) and its intrinsic or fair value. Sometimes investors get caught up in positive hype about a company and believe it is worth buying at any price, thus further driving up the share price. However, once the price moves up to a point where it does not compensate you for the risk that you inevitably take when buying a share, it is time to sell. Currently, investors seem to be pinning their hopes on the technology sector to deliver the outperformance they need. They may be well served to remember that we have been here before. At the time, we called it the dotcom bubble, and the share prices of even the best-quality tech companies fell substantially and took time to recover. Although some of these companies thrived after the collapse of many of their peers, their share prices suffered because they were too expensive to start with.
If I change my strategy, it will be based on facts, not fear
While it is important to avoid getting swept up in prevailing hype or gloom, it is equally important not to ignore the narrative altogether. That said, some of the best investment opportunities can arise from strong negative narratives. In fact, they are often a necessary pre-condition to finding quality companies at attractive valuations. Before you throw in the towel at a point of deep pessimism, make sure you understand why you are doing so, and why you have greater confidence in your alternative option delivering the long-term returns you require. A far better response is a measured rebalancing programme, working towards balancing the longer-term building blocks of your portfolio. For instance, rebalancing an underweight position in your equity portfolio (even to a small extent) after a significant market fall through selective purchases, has a higher probability of success than liquidating the entire portfolio and applying a cash strategy with a wait-and-see approach.
I will strive to keep my emotions in check
Emotions drive financial behaviour, and our emotions are often based on the extent to which our expectations are met or exceeded. Nobody expected a global pandemic, and very few investors will feel that their expectations were met. The best thing to do in uncertain times is to control the ‘controllables’. Unfortunately, market performance is not one of them. But your behaviour is.
I will commit to keeping a long term focus
Many investment gurus remind us that it takes time for a strategy to work, and some of the most admired investment businesses have been built over 30 years or longer. When you review their histories, there were times of uncertainty and hardship. Despite this, those businesses that stuck to their well-proven processes lasted and flourished. Any long-term investment strategy will be tested over time. A key component is how you, as an investor, will respond.