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Wealth Management

The psychology of investing in volatile times

Market volatility is something we are all accustomed to, but recent events have made investors more jittery than usual. China’s ‘Black Monday’ wiped hundreds of billions off the world’s financial markets last month as shares took a beating – and investor sentiment slumped. Locally, the influence of the weak Rand has added to concerns, prompting indecision about what investment strategy to follow.

We all know that fear and greed drive the markets – for example, bias, greed or overconfidence may see individual investors holding a position for too long, while the fear of loss may cause them to sell at too low a price, or exit the market too soon. In their eagerness to make money (or not lose money), they ignore some of the red flags they would pay attention to if they followed a more analytical approach, as institutional investors tend to do.

“Increased market volatility leads to emotional responses like fear or jubilation, leading us to make mistakes and acting when we frankly shouldn’t,” says Simon Brown, seasoned trader and director of JustOneLap. Many of the decisions we make on a daily basis are informed by intuition and we may not always realise this, or allow the realisation to inform our behaviour.

Brown says an investor should ideally not bring emotions into play at all. “The best investor is ruthless and unemotional so he or she can do the right thing at the right time, every time,” says Brown.

“True investors don’t worry about volatility,” says Brown. “It comes and goes. An investor with a passive long-term holding isn’t worried about short-term noise.”

But what about those investors who are so fearful of losing that they fear investment itself?

Adopting a risk-averse investment strategy means showing a preference for a known rate of return over a potential rate of return, even if that known rate of return is lower.

There is nothing wrong with this approach – in fact, it will prevent huge losses – but investors should know that any rewards will obviously be limited. On the plus side, an instrument with downside protection “will help nervous investors sleep better at night,” says Brown.

Structured equity products, however, can still give investors exposure to the growth potential of equity markets (local and offshore) while making sure risk exposure is minimal.

“Investors are usually faced with two typical investment choices; investment in shares – which have historically provided a better return than interest but with volatility along the way and capital at risk – or investment in, say, an interest-bearing investment or fixed deposit account in the bank. The latter provides capital protection and known interest payments,” says Brian McMillan of Investec Structured Products.

“We have found that it is possible to combine these investment styles within a single product. You have the chance to outperform interest rates, should the equities market increase. At the same time the capital protection means that, at the very least, you will not lose your investment capital.”

The ability to extract leveraged returns from equity markets is something of a boon. Brown says investing in these products greatly reduces fear, because fear is all about aversion to downside risk. “But the greed factor can still be satisfied with potential for enhanced upside returns,” he adds.

Investors unwilling to take all their money offshore, but who want to benefit from exposure to strong currencies like the dollar, could investigate a structured product like Investec’s USD Wealth Accelerator, which tracks the S&P 500 Index. “Exposure to growth in the US market denominated in US dollars is a useful rand hedge,” says McMillan. “Investors stand to earn twice the growth in the S&P 500 index over 3 and a half years up to a maximum of 55%, and this gain will be in US Dollars. At the same time the Investor’s initial capital invested is 100% protected on maturity in Rands”.

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