Uncertainty is the norm for financial markets. While it can be unnerving at times, it also provides opportunities for those who are able to stay the course and focus on the long game.
KiwiSaver continues to be the most common form of investment among Kiwis. It can be tempting, when the sharemarket goes down and the value of your portfolio decreases, to react and sell your investments – or in the case of KiwiSaver, switch to a different fund (which is effectively the same as selling the investments in previous your fund and buying the investments in your new fund). Loss aversion is a well-documented tendency, where a real or potential loss is perceived as being psychologically or emotionally more severe than an equivalent gain. Our preference to avoid a loss is stronger than our desire for a gain. The short-lived sharemarket crash last March led to an estimated 20% of KiwiSaver fund holders switching from growth funds to conservative funds - and missing out on the gains when the markets rebounded.
At the same time, a large number of new investors have entered the market using DIY retail investor platforms such as Sharesies or Hatch. A recent FMA study on investor attitudes using these platforms proved that emotions do indeed have a strong influence on peoples’ investment behaviour. These include ‘FOMO’ (the fear of missing out), the visceral excitement investors said they felt when seeing their investments increase, and the anxiety they experience when concerned that the value of their investments will fall.
When applied to periods of market volatility with sharp price movements, many investors (especially new ones) can become unnerved and question their investment strategy. Some may even be tempted to pull out of the market altogether until it smooths out again. Watching the market every day isn’t necessarily beneficial and can lead to emotion-based investment decisions that may not be beneficial in the long run.
The FMA’s study identified two underlying beliefs that investors generally display when thinking about how investing could increase their wealth; either by ‘timing the market’ (buying low and selling high) or ‘time in the market’ (holding on to investments for long term growth and dividends).
Those who believe in ‘timing the market’ tend to monitor their investment portfolios frequently and think it is possible to make more money through good research and understanding the listed businesses better than the average investor – though the study also identified that their ‘research’ is often only to confirm their existing hunch.
While a volatile market presents opportunity, it also presents risk. Indeed, trying to time the market is extremely difficult. Many full-time professionals regularly fail to guess which way the market will move in the short term. “Day trading” is in the minority in New Zealand, with just two per cent of investors buying and selling multiple times a week. It could be argued that such short-term trading is more akin to gambling than it is to investment. Day trading can also be detrimental to the listed business as it can create instability in pricing, which puts off longer-term investors.
Conversely, those who believe in ‘time in the market’ tend to monitor their investment portfolios less frequently, maintaining the opinion “slow and steady wins the race.” In line with this belief, one way to deal with volatility is to ignore it by not paying attention to short-term price fluctuations and maintaining a long-term horizon. Over time, the peaks and troughs of a volatile market will iron out. Though it may sound like a simple strategy, watching your portfolio take a significant hit and still staying the course takes a fair amount of confidence. Doing your due diligence, investing in companies with strong fundamentals and maintaining a diversified portfolio can help make sure your investments (and your investor confidence) will fare well in times of market volatility.
If you do find yourself in a position where you need to trade, the type of order you choose can be very important – particularly where prices are changing rapidly throughout the day. Most often, a limit order will be your best option in times of volatility – an order to buy or sell securities at a specified price or better. Though a limit order does not guarantee you a trade (as there may not be a willing buyer or seller who will trade at the price you’re asking for), you won’t receive a price you weren’t expecting. A market order, on the other hand, will always be executed. It is an order to buy or sell securities immediately at the best available price in the current market. You may receive a price that is substantially different than the price you were quoted when you placed your order, as in traditional stock exchanges, the markets can move quickly.
In a traditional stock exchange, where the market can move incredibly quicky, it is important to know your risk tolerance and understand how market volatility and your portfolio’s price fluctuations will affect you emotionally. Daily monitoring of your share portfolio is not necessarily the best strategy. Instead, looking at the long-term horizon and only checking in periodically allows volatile markets (and emotions) to smooth out.
Catalist was designed to encourage longer-term investments in SMEs, where you can still trade if you need to. However, instead of continuous trading, Catalist uses periodic auctions, meaning trading only occurs when there’s an auction running and everyone gets the same price at the end of the auction. Auctions could be held quarterly or once every six months, for example. Not only does this reduce market volatility, but it also means you only have to monitor your portfolio when a relevant periodic auction comes around. So, no more worrying about whether you’ve missed that important bit of news, allowing other investors to get the jump on you.
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By Michelle Polglase