Nervous investors may be considering phasing-in their investments, but does it make sense?

At the time of writing this article, the market was down around 15% from its high in April 2015, the rand continued to fall to the dollar at 35% weaker than a year ago and the MSCI World Index was down over 10% from its high in dollar terms.

Financial advisers and their clients are understandably feeling nervous about what the rest of the year will bring and whether now is really the time to invest a lump sum. For a while now, the general advice has been to phase in your money over a six- to twelve-month period rather than to invest a lump sum.

This may sound like a sensible strategy but interestingly, research by Wade Witbooi, retail investment analyst at Sanlam Investments, found that generally, phasing-in is not a good investment strategy.

His research covered the period from July 2000 to July 2015 where for each month he assumed an investor made the decision to phase in either over six months or twelve months and then compared that to how the market had performed during that phase-in period.

For high-equity funds where the fund invested primarily in equities (shares), he found that 83% of the time a lump-sum investment would have outperformed the phase-in approach over six months; over 12 months, more than 90% of the time investing a lump sum was a better strategy. Remember that the huge market crash of 2008-2009 fell inside the period under review, which accounted for the periods where the phase-in strategy was very beneficial. According to Witbooi it is only in extreme market crashes that the phase-in approach actually works. The problem is that we don’t know when we are facing a relatively small correction or a historical crash.

Managing investor emotions

While statistically you should just ignore phasing in as a strategy, Andrew Bradley, CEO of Old Mutual Wealth, argues that when it comes to managing investor emotions, phasing in can be the better investment strategy.

“For an adviser, the biggest risk of a market correction is client management and expectations and the first annual review of a client’s investment portfolio is the most crucial,” says Bradley who explains that if after a year or even six months a client sees that their investment has fallen or that they would have been better off in a cash investment, they will often panic and decide to sell at the worst possible time, compounding their losses. Even if an adviser has fully explained market volatility, the perception of loss creates huge anxiety for investors.

As Witbooi explains, humans suffer more from the pain of loss, than the relative joy from a gain. “Behavioural economist Daniel Kahneman observed that humans typically experience the pain of loss with double the intensity than they experience the pleasure from an equivalent gain. This fear of loss is innate to all human beings and could lead to irrational investor behaviour,” explains Witbooi.

For this reason Bradley recommends that if an investor is concerned about short-term market volatility then a phase-in approach is more sensible. “A three- to six-month phase-in period would be an astute approach; the more volatile the markets, the longer the phase-in period as nothing stops you from investing the remainder of the funds once the market stabilises. I wouldn’t however advise a period longer than a year,” says Bradley.

Consider a shorter phase-in period

However, given the current market levels, Witbooi makes the valid point that from an investor’s point of view the fact that the market is already down by 15% has already reduced the risk of investing and the need to phase in. In fact, a phase-in strategy would have suited the last six months possibly better than the coming months, so if you still want to follow a phase-in approach, then a shorter period may make more sense at this stage.

An alternative is to invest your lump sum in a multi-asset fund that can invest across seven different asset classes, including bonds, cash, offshore and derivatives. This reduces your exposure to a single asset class. All balanced funds and flexible funds fall into this category.

“Another tool to decrease an investor’s exposure to falling markets is the use of derivatives to hedge out at least some of the market risk. Funds that use this technique are normally a subset of the multi-asset fund category. In addition to making asset-allocation calls, they therefore also buy ‘insurance’ (through derivatives) against falling markets to protect investors’ money, while at the same time exposing it to growth opportunities,” explains Witbooi.

The thing one needs to keep in mind with multi-asset funds is whether or not they meet your personal long-term investment objectives. Someone with a 15- to 20-year investment time horizon may want to be fully exposed to equities, so a multi-asset fund may not meet those needs and a phasing-in strategy (to calm the nerves) into a high-equity fund may be a better alternative. If, however, you are the sort of person who, even with a long-term investment horizon, would be tempted to cash in with every market movement, then perhaps a lower-risk, multi-asset fund could be the right solution for you because even though your long-term returns may be lower, trying to time the market is the fastest way to lose money.