Fear investing? It is normal - but can be managed

NAV TL;DR

If you don’t have time to read through the whole article, you can check out our short version below:

“Loss aversion” is normal but can cost you dearly. The loss of spending power through inflation may happen if you hold too much cash over the long term.

Rein in your fear of investing—understand that time is your friend. Studies have found that the longer your holding period for stocks, the lower your probability of incurring a loss.

Get to know yourself, understand the investments you want to make, and be comfortable that you can stomach whatever risks you are taking on.

If you are afraid of investing, take heart that this is quite normal behaviour.

It may not be helpful behaviour if you want to build a larger retirement nest egg. But this phenomenon called “loss aversion” is very well established as “normal” in humans. We generally fear losing money.

A study by American economist and professor, Richard Thaler, and others from American universities said “empirical estimates find that losses are weighted about twice as strongly as gains”. The “disutility” (or loss of satisfaction) of losing S$100 is “roughly twice” the “utility” (satisfaction) of gaining S$100. In simpler terms: You feel happy to receive a S$100 hongbao, but would be twice as sad if you forgot to take your withdrawn S$100 from the ATM.

The investment choice over many decades has been between 1) the possibility of a near-term loss through investment or 2) the certain loss of spending power through inflation, by holding cash over the long-term.

US$1 million from 1926, held literally in cash—the metaphorical “money under the mattress”—will today have lost around 93% of its spending power. Put simply, the US$1 million will be able to buy only around 7% of what it would have been able to buy 93 years ago. Similarly, the savings you have now will most likely be worth a lot less in real spending power in 20 years.

The long-term history of US stocks, bonds, and cash tells us that stocks perform best, bonds next, and cash in a bank account barely keeps up with inflation.

Although the Singapore market has a much shorter history than the US market, it paints a similar picture: stocks performed better than government bonds. Cash deposits fell way behind inflation.

For example, over the 10 years from 1 January 2009 to 1 January 2019, the Straits Times Index—which tracks the performance of the largest 30 companies (by market capitalisation) listed on the Singapore Exchange—achieved an annualised return of 10.3%. Over the same period, Singapore government bonds recorded an annualised return of 4.8%. But the cash deposit rate ranged from only around 0.38% p.a. to as low as 0.13% p.a. These compare with the average annual inflation rate of 2.1% p.a. in the 2010-2016 period.

How do you manage your fear of investing? Start by understanding that time is your friend in investments.

Studies have found that the longer your holding period for stocks, the lower your probability of incurring a loss. For example, Morningstar’s study of US stocks from 1926 to 2017 found that 26% of the stocks recorded negative one-year returns. But when the holding period was lengthened, all 15-year period annualised returns were positive.

In addition, if you have never invested or are relatively new to investing, consider starting small and building your investments over time. This will also help you build investing discipline by setting aside money regularly for investments.

Regular savings plans are useful in this regard. DBS’ Invest-Saver, for example, lets you buy exchange traded funds and unit trusts from as little as S$100 a month.

Notwithstanding the evidence supporting the case for long-term investment, your personality and personal circumstances may not lend themselves to taking on too much risk. Hence, you have to know yourself, understand the investments you want to make, and be comfortable that you can stomach whatever risks you are taking on.

All banks and other financial institutions will assess your risk profile before recommending or selling you an investment product. The questionnaires vary, but the key elements tend to be your investment time frame, experience, personal financial circumstances, and ability to accept losses.

They will rate you on a number of risk categories, all of which then determine the type of investments they will offer you. These are questions you should think through and answer carefully because a mismatch between your risk appetite and your investments may cause you emotional or financial discomfort. And that, in turn, may result in you selling a loss-making investment that may in time turn profitable if you had held on for longer.

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