How to be a human be-ing, not a human do-ing
We are so busy in our lives today. Decisions are made instantaneously, but knee-jerk reactions are often the wrong course of action. Taking the time to evaluate a situation can lead to a more informed decision and a better result in the long term.
We are human be-ings not human do-ings; we don’t always need to be active and taking immediate action.
Quick decisions are often made because of fear
We are scared of failing, or losing control. Switching away from a poorly performing investment is a case in point, as it is human instinct to not want to suffer through poor performance.
It is very difficult to not look at short-term investment returns. During these periods many investors may be tempted to take swift action and switch out of a poorly-performing fund into a fund that has performed better. Although this may appear to be a sensible way to generate better returns, switching funds during periods of poor performance can destroy the value of your investment.
You have to sell your units, which will usually incur ‘friction costs’ (all the direct and indirect costs associated with a financial transaction, such as transaction fees and taxes). It also locks in the underperformance of the fund that you are switching from. Simultaneously, there are no guarantees that the fund that you switch into will be able to repeat its recent strong performance. By switching you are often selling and buying at exactly the wrong time.
Managing the urge to switch
There are many reasons why we switch. Next time before we do it, it is worthwhile considering the following three factors to judge how much of a role they play in the decision making.
1. Our emotions
You would not be human if market volatility didn’t create a sense of fear, or at least make you uncomfortable. These emotions often lead to taking action that will permanently lock in losses, or missing the best time to invest.
Your role as an investor is to pick a managed fund on the basis that it suits your needs and objectives and that you trust the fund manager – not solely on account of recent performance.
Various studies have shown there is no correlation between economic growth and share returns, but investors often study macroeconomics to attempt to predict market returns.
In the end, what determines the success of your investment is the price that you pay for an asset, and how much return it generates.
3. Rare events
Sometimes events occur that are incredibly rare and extremely difficult to predict. These can have a major effect on markets and investments, for example the September 11 attacks and Brexit. The impact on your portfolio can be significant, but these events are highly unpredictable. It is not a good idea to base your investment decisions on what could ‘possibly’ happen.
To benefit when switching funds, you have to be able to choose the best times to leave and enter the market. This is nearly impossible because markets can swing wildly from day to day in response to a variety of unpredictable factors.
Remaining invested when faced with poor performance will take strong nerves. But if you can steady your emotions, and keep in mind the reasons why you invested in the first place, you can ride out a difficult period and hopefully enjoy good returns in the future. It would have been tempting to switch your investments in the final quarter of 2018, but since the start of 2019 the ASX 300 Index is up almost 23% (to 30 September 2019).
Sometimes there are good reasons to switch
For example, if your, or the fund’s, objectives, change then your investment may no longer be suitable. You may have lost faith in the fund manager, or maybe you simply need to rebalance your portfolio.
Before making any decision, investing or otherwise, it’s important to slow down, take time to re-evaluate the situation and focus on your long-term priorities. In today’s world the urge to take immediate action can be overwhelming, but sometimes the best course of action is to do nothing at all.