Personal-Finance

Phase in, or take the plunge?

2016-02-28 13:06

At the time of writing this column, the market is down about 15% from its high in April 2015, the rand is 35% weaker against the dollar compared with a year ago and continues to slide, and the MSCI World Index is down more than 10% from its high in dollar terms.

Financial advisers and their clients are understandably feeling nervous about what the rest of the year will bring, and whether now is really the time to invest a lump sum. Generally, the advice has been, for a while now, to rather phase in your money over a six- to 12-month period instead of investing a lump sum.

This may sound like a sensible solution, but research by Wade Witbooi, retail investment analyst at Sanlam Investments, found that phasing in was generally not a good investment strategy.

His research covered the period from July 2000 to July 2015, where for each month he assumed an investor made the decision to phase in either over six or 12 months and then compared that with how the market had performed during that phase-in period.

For high-equity funds, where the fund invested primarily in equities (shares), he found that 83% of the time, a lump sum investment would have outperformed the phase-in approach over six months and over 12 months.

Remember, this period fell over the huge market crash of 2008/09, which accounted for the periods where the phase-in strategy was very beneficial. According to Witbooi, it is only in extreme market crashes that the phase-in approach actually works.

The problem is, we don’t know when we are facing a relatively small correction or a historic crash.

While statistically you should just ignore phasing in as a strategy, Andrew Bradley, CEO of Old Mutual Wealth, argues that when it comes to managing investor emotions, phasing in can be the better investment strategy.

“For an adviser, the biggest risk of a market correction is client management and expectations, and the first annual review of a client’s investment portfolio is the most crucial,” says Bradley, who explains that if after a year or even six months a client sees that their investment has fallen or that they would have been better off in a cash investment, they will often panic and decide to sell at the worst possible time, compounding their losses. Even if an adviser has fully explained market volatility, the perception of loss creates huge anxiety for investors.

As Witbooi explains, humans suffer more from the pain of loss than the relative joy from a gain.

“Behavioural economist Daniel Kahneman observed that humans typically experience the pain of loss with double the intensity than they experience the pleasure from an equivalent gain. This fear of loss is innate to all humans and could lead to irrational investor behaviour,” explains Witbooi.

For this reason, Bradley recommends that if an investor is concerned about short-term market volatility, a phase-in approach is more sensible.

“A three- to six-month phase-in period would be an astute approach. The more volatile the markets, the longer the phase-in period, as nothing stops you from investing the remainder of the funds once the market stabilises. I wouldn’t, however, advise a period longer than a year,” says Bradley.

However, given the current market levels, Witbooi makes the valid point that from an investor’s point of view, the fact that the market is already down by 15% has reduced the risk of investing and the need to phase in. In fact, a phase-in strategy would have better suited the past six months more than the next month’s, so if you still want to follow a phase-in approach, a shorter period may make more sense at this stage.

An alternative is to invest your lump sum in a multiasset class fund that can invest across seven different asset classes, including bonds, cash, offshore and derivatives. This reduces your exposure to a single asset class. For example, all balanced funds and flexible funds fall into this category.

“Another tool to decrease an investor’s exposure to falling markets is the use of derivatives to hedge out at least some of the market risk. Funds that use this technique are normally a subset of the multiasset fund category. In addition to making asset allocation calls, they therefore also buy ‘insurance’ [through derivatives] against falling markets to protect investors’ money, while at the same time exposing it to growth opportunities,” explains Witbooi.

The thing one needs to keep in mind with multiasset classes is whether or not they meet your personal long-term investment objectives. Someone with a 15- to 20-year investment horizon may want to be fully exposed to equities, so a multiasset fund may not meet those needs and a phasing-in strategy (to calm the nerves) into a high-equity fund may be a better alternative.

If, however, you are the sort of person who, even with a long-term investment horizon, would be tempted to cash in with every market movement, perhaps a lower-risk, multiasset fund could be the right solution for you because, although your long-term returns may be lower, trying to time the market is the fastest way to lose money.

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