Personal Investing
11 Mar 2019 12:25pm

In a turbulent world the easy option will prove costly for investors

SPONSORED CONTENT: Stock market indices like the FTSE 100 are averages, so the story they tell is only a partial truth. They don’t reflect the experience of an investor in any single share which, as a result of simple arithmetic, is almost certain to be better or worse - often materially so - than the performance of its benchmark index

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Caption: Thomas Cook's shares are more than 30% lower than they were a year ago

I suppose I should not have been surprised, therefore, by the share price charts of many of the companies currently announcing their 2018 results as we navigate earnings season. But I have been struck by just how many widely-held shares have endured a terrible 12 months. Here are just a few of the names which are more than 30% lower than they were a year ago: WPP, BAT, Royal Mail, TUI, Kingfisher, Thomas Cook, Carpetright, Asos, William Hill, Metro Bank, Ted Baker, Purplebricks.

These are not illiquid and volatile smaller companies that you would expect to provide a volatile ride. BAT, for example, is valued at £64bn. But in the past year and a half, its share price has been as high as £55 and as low as £24. Asos is not on the same scale, of course, but it is a leading player in its online fashion niche. You could have bought the shares in 2018 anywhere between £77 and £21.

If you invest in funds (which, like the indices, are a kind of average), or passively track the performance of an entire market through an exchange traded fund (ETF), you are naturally protected from the brutal reality of the stock market’s tendency to overshoot in both directions. That will suit many investors - it is a lot less stressful. But the price you will pay is missing out on the opportunity this volatility provides. It is only because the stock market is inefficient that you can make money in it.

When something dramatic happens, you expect a significant share price movement. But very often big rises or falls simply reflect a shift in sentiment. Take BAT again. There are plenty of plausible reasons to dislike the tobacco sector and BAT in particular. These range from the ethical (its product is a killer) to the regulatory (ditto, complicated by tax and lobbying) and, in this instance, the financial too (BAT’s debts have risen materially since it expanded in America last year). But none of these are exactly unexpected. And with a safe dividend yield of more than 7%, if you are relaxed about the moral position you are taking you are now being well compensated for the risk.

So, as the share price has halved over the past couple of years, a holder of BAT has been confronted with plenty of opportunities to do one of three things with their investment. Once it had fallen by enough that the movement could no longer be dismissed as market noise, an investor had to choose between cutting their loss by selling, buying more or doing nothing. My guess is that the vast majority of investors opted for the last of these.

There is a wonderful short book called The Art of Execution, written by a fund manager called Lee Freeman-Shor and published four years ago by Harriman House. If you are even remotely interested in how to invest, go and buy it today. It will take you a couple of hours to read and you will wish you had done so years ago. Most of this short guide is on precisely this question: what should you do when an investment goes wrong?

The answer, if you’ll forgive the spoiler, is what most of us avoid. It is to do one of the other two options - sell or buy. Doing nothing is always the wrong thing because the share price you are looking at will almost certainly not stay the same. It will go down or it will go up. So, if you have decided to invest in individual shares (clearly not the right choice for everyone), you need to decide which it is going to be.

Freeman-Shor groups investors into three ‘tribes’. Those who bite the bullet and clear out the underperformers from their portfolios are called ‘assassins’. There is merit in this approach, especially if you also run the profits being made on your more successful investments. It is this combination that enables people to make good money even if their success rate is less than 50%. A few big winners can more than offset a larger number of losers if you cut your losses and run your profits.

The second group are ‘hunters’. These are investors who have the rare ability to say ‘I bought this share higher than it is today, it is now even cheaper than it was, how lucky that I can now buy some more.’ The reason this group is rare is because it is difficult to admit you got something wrong and still see it as an opportunity. If you don’t think this is hard, try it.

Because it is hard to be either an assassin or a hunter, most people tend to fall into the third category of investor - the ‘rabbits’. The reason why there are so many more rabbits than the other two types of investor is that what defines this group is being human. Investment rabbits are afflicted by psychological biases that help us survive in the real world but make us bad investors: they fall in love with stocks, they can’t wait for rewards, they are swayed by the herd, they blame the market, they look for confirmation of their prejudices not the facts, they can’t admit they were wrong.
There are things you can do to stop being a rabbit. And there are questions to ask yourself to decide whether to be an assassin or a hunter in any given situation. But that’s for another week.

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Important information

The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.