Evan Lucas* provides investors with a strategy to shake off market paralysis.
We received an email from a fantastic long client that stated they were experiencing the following:
I’m suffering from a lack of confidence in my direction with investing at the moment!…
I find this period really difficult to navigate – returns for low-risk assets are below inflation, the market looks pretty unstable & I find that I just end up doing nothing and have too much in cash.
We wanted to share this with you to show you that they are not alone and to provide you with thoughts and research on how you can address the points raised by this client:
We all know that investing comes with risk – that is the trade-off we all have to accept, the higher the returns the higher the risk of a negative.
It is what legendary American economist Harry Markowitz proved to win the Nobel Prize in 1952 with his Modern Portfolio Theory.
He proved that market risk is more than made up for by the average yearly returns which should satisfy an investor’s overall return expectations.
He also stated that to mitigate the risk an investor will create a diversified portfolio that provide the maximum returns at a level of risk the investor finds acceptable.
It’s all well and good for us and Markowitz point this out but it doesn’t help with the investor behaviour negative risks create.
Studies have found that even when an investor selects a risk profile during times of risk all levels of risk can become unacceptable to investors, as the mere prospect of loss or an investment that is seen as too unpredictable leads to inaction and money conservatism.
This should give you heart, you are not alone in think like this and seeing your investment behaviour change because of current forces.
The studies also find that this leads to a higher level of anxiety.
Anxiety is a major player in obstructing decision making and can lead to no choices being made at all.
This can feel like the easier option rather than making a decision that turns out to be ‘wrong’ or leads to loss.
Again, we say – ‘give yourself a break’ it is natural to feel like this and natural to say, ‘it’s all to hard’ and not do anything.
But there are ways to help you break your inaction and keep you investment strategy working even when your behaviour may want to go against your goals.
Automate, Automate, Automate
One of the best ways to remove the fear of choice is to automate your investment strategy.
Take away that ‘choice’ of not doing anything by committing to reinvesting your dividends with a dividend reinvestment plan.
Look to add to your investment portfolio on a consistent basis by using programs such as contribution plans or sweeps.
This does two things, stops your natural behaviour from impacting your strategy but it also allows dollar cost averaging to take effect.
Dollar cost average occurs when you invest consistently without interruption.
For example: say you invest $500 every fortnight, month or quarter.
You invest this amount regardless of the fluctuations in the investment markets in each time period.
This means that you are buying less of an investment when market (or asset) prices are high, and more when market (asset) prices are down.
This will mean over time the average price of your investments will moderate to a better price and the scale of your investment capital will be larger – giving you a higher exposure to the effects of compound interest.
By all means hold some cash on the sidelines if this provides you piece of mind and deploy that cash when you are ready.
But having some automation will allow you to increase your investment pool during the good and bad and will conquer that issue of inaction and indecision.
*Evan Lucas, Head of Strategy at InvestSMART.
This article first appeared at investsmart.com.au.