What are permanent investment losses and how can they be prevented?
Taking a longer-term view will make short-term volatility matter less, and you will feel less inclined to act on every short-term move
Don’t lock-in permanent losses:
No one likes thinking of losses – never mind permanent ones. And, we don’t need a behavioural expert to tell us that when it comes to investing, we feel the pain of losses (or even just declining markets) much more intensely than the satisfaction of positive investment returns.
It should by now be a well-known fact that the average investor does worse than the market. The biggest reason for this underperformance is the fact that these investors allow their emotions to get in the way of their long-term investment needs and goals, which sees them buying high and selling low. On the one hand, the average investor tends to get overexcited and buys when markets or funds are rising (becoming more expensive) and when there is an abundance of good news.
On the other hand, the average investor panics and sells when news flow is bad and markets or funds have declined. It’s these actions that significantly dent the chances of meeting long-term investment objectives.
What is a permanent loss?
We see a ‘permanent loss’ as a loss that will be very hard or impossible to make up. One way to define this is when the value of something is impaired
forever, or for the length of your investment horizon, regardless of whether you have sold the investment and realised the loss, or not.The other way to define a permanent loss is to look at what happens when you sell a good asset in a bad situation. In other words, when the reduction in market price was temporary, and in fact a buying opportunity.
Markets go up and down and, in the short-term, there is little logic to how the markets reflect news and other information.
This makes it very hard to avoid taking actions that will incur a permanent loss.
So how do investors prevent this?
How to prevent permanent losses?
Careful selection of your investments is the real key to preventing the locking in of a permanent loss. The key assessments you have to make to determine quality are whether the company has a strong business model (look at all that this ideal entails, such as pricing, cash flow, a growing market and the like) and if the company has trustworthy, capable management (look at whether they own shares, and how they have acted for
shareholders in the past). These actions will bring you closer to having shares with better businesses and better management teams, who are able to respond to the environment with shareholders’ interests at heart.
Higher quality certainly deserves a higher valuation, but the general rule here is to not overpay for any asset.
Buying an investment, be it a business, share or house in an inflated situation, seldom pays off.
If you can harness the essentials of taking a long-term view coupled with a quality assessment and, crucially, not overpaying for the asset when you buy it, you will be much closer to avoiding the costly mistake of locking in a permanent loss.
Author: Anet Ahern, PSG Asset Management
For investment advice contact one of the advisers at PSG Wealth Melrose Arch on 011 721 0600 or email@example.com
How multi-asset funds can help manage wealth-destroying behaviour
As investors, we are often our own worst enemies. Although most investors blame the market for not meeting their investment goals, the reality is that it is usually due to their own behaviour.
The good news is that investments can be managed by putting the right plans and strategies in place, sticking to them and by using the right investment vehicle. Multi-asset funds combine a variety of asset classes, providing a mix of growth assets such as shares, and more stable assets such as cash, in line with their respective mandates and objectives.
The funds are professionally managed and continuously rebalanced ensuring they retain exposure to the right types of assets in varying market conditions. By taking the pressure off the individual to select the right funds, investors are also relieved of having to react to market developments – and potentially making the wrong decisions in the face of fear.
The Association for Savings and Investment South Africa (Asisa) reports that most net new retail investments were invested in the South African Multi-Asset High Equity sector – also known as balanced funds – in the last quarter of last year.
These funds comply with the Prudent Investment Guidelines, as set out by Regulation 28 of the Pension Funds Act, and are popular choices for pre-retirement investments (retirement annuities, preservation funds, pension funds and provident funds).
Most investors are familiar with the term “diversification”. It is one of the cornerstones of sound investment strategy. Wall Street equities analyst, Barry Ritholtz, put it simply when he said: “The beauty of diversification, is that it is about as close as you can get to a free lunch in investing.”
As investors, we need to always take cognisance of this particular principle if we are to ever achieve our investment goals. For this reason, all of us should have at least some interest in offshore assets. Regardless of your optimism or pessimism towards the future of South Africa, it would be prudent to have a portion of your total portfolio externalised.
When we consider the fact that South Africa’s GDP represents only 0.37% of the world economy, we begin to see just how over-exposed we are to this country. Most of us build our houses on South African soil, we run our businesses proudly South African, and we earn and save our money in South African Rands, yet most South Africans hesitate when it comes to foreign investment.
We believe that part of this hesitation stems from the uncertainty and confusion around investing overseas. This is entirely understandable. There are over 60,000 listed companies to choose from around the world, the currency seems to be getting more and more volatile every day, and foreign tax laws and exchange controls are perpetually changing. In addition to this, there seems to be a prevailing assumption that investing offshore is expensive, and difficult. It is simply too easy to become overwhelmed.
The reality is that the costs involved in investing outside of South Africa should be no different to a local investment, and a good financial adviser would be able to make the entire process surprisingly simple.
While currencies will fluctuate over a short-term period, the long-term trend points to a weakening rand. By investing offshore, not only are you reducing your risk by asset diversification, but also by hedging against rand depreciation. Foreign investment also affords the investor access to a vast universe of opportunities not found on local shores.
One of the primary goals of most investment portfolios is to grow with or above inflation. You might not realise it, but you have a specific rate of inflation applicable to you and your lifestyle. A good exercise to do, is to evaluate the kinds of goods and services that you use daily, and consider whether or not they are produced in South Africa, or overseas. Your car, its fuel, your mobile device, your internet streaming services, your medicine, and even your food, is all linked to the U.S Dollar. In order to keep up with the inflation applicable to these foreign goods and services, your wealth needs to appreciate in international terms.
The fundamentals show that international stock markets offer long-term inflation-beating growth whether measured in rands or hard currency. That being said, you are not limited to offshore equities alone. There are solutions available to investors anywhere on the risk spectrum. Whether you are more inclined to conservative investments or whether your appetite is for more dynamic growth; there is a solution that will suit your specific needs and goals.
While returns and risk-profiling are important considerations to make, it is equally important to consider the offshore investment structure itself. Tax and estate planning consequences of the various offshore structures will vary; and we once again recommend that you seek professional financial advice on this topic, should you wish to make an informed decision.
While it would be difficult to broadly talk about a pre-defined portion of wealth that should be invested offshore without evaluating your specific portfolio; we do believe that your ideal percentage will be higher than you think.
Author: Cameron Muller, Wealth Manager at PSG Wealth Melrose Arch