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When you are calm and composed while the rest of the people around you are in a state of frenzy, then it’s very likely that you are on the wrong side of the stadium.
When the rest of the market in the first four months of this year had their rose-tinted glasses on and were in a state of euphoric buying while the market continued to set new records, your column writer admittedly felt anxious and troubled.
Now that the market has tumbled from the highs, giving back more than eight percent of its gains at one point - and investors have become desperately at sea - scanning the horizon for the direction home, this writer has become calm and at peace with the world. Because nothing has really changed: the market’s fundamentals remain the same. It’s only people’s perception of the investment environment that has changed.
When the market changes direction, do you change your investment strategy? If you’re male and fancy yourself as an active fund manager, you probably would answer in the positive. Recent studies have shown that male investors are more likely to actively trade their stock portfolio than would their female counterparts. Why is that? The news article did not say, but it may have something to do with the alpha male syndrome, where the man always thinks he has to be in control of any situation he finds himself in. As a result, it should come as no surprise that female investors tend to have better returns than male investors.
The buy-and-hold strategy does not get much respect in the local market, given the machismo testosterone-laden environment of the Philippine market. It is ironic, however, that it is fear that drives the short-term strategy of active fund managers. Fear of short-term losses in the market drives most people, not only active funds, to head for the exit signs when the market starts to stall and lose altitude.
Partly due to risk aversion and partly due to their need to justify the high fees they charge fund investors, active fund managers tend to cash in their gains, go into cash (i.e., shift the proceeds to the money market, which is highly liquid but provide miniscule returns), and then wait for stock prices to become cheap as an entry point for going back to the market.
Individual investors - who tend to be male - think this is a cool strategy and try to emulate this. The result is that these people tend to sell in fear when prices have already fallen significantly, and try to buy back when prices have already bounced back. This is formula for sizeable market losses or significant underperformance.
There are a number of things wrong with this myopic strategy.
First, a strategy that has a crystal ball as its prime requisite, to tell the investor where the market would be headed in the short term, cannot be a consistently effective strategy. The market has always gone up and it has gone down, and guessing correctly whether it’s heads or tails would provide a fifty-fifty odds at best. The best way to participate in this market would be to stay invested in it. Doing so would mean that the investor would be able to ride out the lows and be invested at the peaks, while avoiding all sorts of onerous trading fees.
Secondly, even if one were to consistently guess and trade correctly the market’s peaks and troughs, numerous studies have consistently shown that an actively traded portfolio that shifts from stock to cash, and back again, cannot outperform, over the long run, the return of a portfolio that has a buy-and-hold strategy.
Lastly, most people don’t have the nerves nor the market discipline to sell a losing position or to catch a falling a knife, which the active management strategy would occasionally call for. They would normally “wait for the confirmation of a trend reversal” before they commit themselves to a position. By then, the market has run away from them.
Successful investors, as some commentators have put it, are those who are well-balanced in their outlook, i.e., they don’t get carried away by the crowd’s emotions; they maintain a diversified stock portfolio; they invest for the long term and not be misled by short-term market perturbations; and they invest in, and hold on, to well-managed businesses that they have personally researched and studied.
In a bad market, the best advice would be this: Don’t just do something, stand there! This is the do-nothing mantra of the long-term investor.
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