21/02/2024
Understanding yourself as an investor.
On my first day in the office this year, I sat down at my desk. As I sat my boss dropped a wad of results of various other funds in front of me.
My eyes glazed over the sheets, scanning the worst and best performers before the words “F*ck me! 96% !” punctuated the air of innocence on my first morning cleanly shaved in a suit and tie.
I was referring to a fund that had way outperformed competitors returning 96% by focusing mostly on tracking the magnificent 7.
The question I asked: how the hell did they do so well? and more importantly why had I not invested with this fund?!
There are various answers layered in a study of technical and fundamental analysis, but the easiest answer and most honest answer as to why they did so well: AI.
My boss then answered the second half of my question, why had I not invested in this fund?
Besides the obvious: (I was overseas and at any given stage half way down a bottle of wine, enjoying “la dolce vita”, finding funds with superior returns was not at the forefront of my mind). The real answer is the truth lay in the results from the year prior: A negative 31.8% return.
Had you started investing in the beginning of the 2022 year, you’d have found yourself strapped of 31.8% of your initial investment.
Had you had the guts to keep your severely bruised investment in for a consecutive year you’d only be up 34% on your initial investment that you made in the beginning of 2022. That is not a bad return when you annualize it over 2 years but required a significantly and outrageously good return in year 2 of 96% to get you out the mud.
In simple terms to understand: An investment of R100 that suffered a 50% loss in year one would require would require a 100% return in year 2, to get back to the initial investment value of R100. Only after returns of a 100% would you start making money on your initial investment. An essential component to long term investing is avoiding high drawdowns. High drawdowns can take ages to recover.
Two questions were put back to me:
1. Would you have had the guts to keep your money in for another year after losing 31.8% of your investment? Probably not I answered.
2. Would you have invested in this fund at the start of 2023 after having viewed their 2022 results of negative 31.8%? Certainly not.
My boss replied, “well exactly, some people would run for the hills and never invest again because their short-term financial needs and goals would have been crushed but some others would have held on, having time on their side and realized returns later on”.
It does all feel like a bit of a gamble sometimes and essentially you do not want investing to feel like a gamble. However, when you expose yourself to big upsides you also expose yourself to cruel downsides.
Investing is done best when you understand yourself best. Understanding your risk tolerance is essential. Understanding your investment horizon is essential. Understanding your need for liquidity is essential. Understanding your financial goals (short and long term) is essential.
Do you want to buy a car in 6 months? Does your girlfriend want you to propose next year? Are you happy to sit on the investment for 7 years?
Furthermore, distinguishing the reasons for a fund’s performance or lack thereof. You need to understand the product and when a good time to invest is. Sometimes after a heavy pounding of a funds value, it is the best time to enter, as it is at its lowest of lows, sometimes after a massive outperformance relative to other funds, you should start considering to sell your positions and sometimes the decision you make will be completely wrong.
It is important you are transparent with yourself on all those kinds of questions and outcomes. Once you are, only then can you start making investment decisions where you are comfortable to ride the waves of returns and the feelings attached to them.
Once I asked myself the same questions, I actually realized I would have been able to put my head down and wait on through the big downside of the 2022 year in that fund, albeit it I may have moaned and groaned and finished the other half of my bottle of wine.
Risk is unavoidable, feeling the heat at times is unavoidable, thinking you are a genius at times is also unavoidable. The key to it all is to stay grounded, stick to an investment strategy that you understand but more importantly that suits you because you understand yourself.
Now for some company-promotion, if you interested to understand more about your own investor profile and tolerance: contact us and do a survey, we can then advise you on the best investment plan for you.
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