City thinking, local knowledge

The Investment Theories which go Against Conventional Wisdom

By Questa Chartered

Many of you will have heard the old stock market maxim; ‘Sell in May and go away.’ It ended with, ‘Don’t come back until St. Leger day’ and held that the best investment practice was to sell up in May and enjoy the English summer season, the Lord’s test, Ascot and Henley.

Sadly, Wall Street and the Shanghai Composite Index don’t take too much notice of the English season, and that old advice has rather dropped out of favour!

But are there any other seemingly outdated investment theories and should you pay any attention to them?

Perhaps we should start with the ‘Greater Fool Theory’ which, very simply, says it doesn’t matter what you pay for an investment as long as you can find a ‘greater fool’ to buy it at a higher price. These days the Financial Conduct Authority do not recognise ‘greater fool’ as wholly satisfying the requirement to ‘know your client…’

‘Buy the worst performing market.’ Has one of the world’s stock markets performed poorly this year? Then believers of this theory say you should invest in it next year. 2019 was generally a good year for world stock markets, but of major markets South Korea lagged behind, only rising 9%. The Brazilian market, in contrast, rose by 32%. What happened in 2020? South Korea was up by 31%, Brazil by just 3%. And anyone following this theory will be heavily invested in the UK’s FTSE index in 2021 – compared to other countries, the UK’s leading index performed poorly in 2020.

The ‘Prospect Theory’ tells us that investors are more worried about the prospect of loss than they are attracted by the expectation of profit. If a portfolio grows at a steady 5% for three years it will – allowing for compound interest – have the same return as one which grows 12%, falls 2.5% and then grows by 6%.

The theory tells us the majority of investors will opt for the steady 5% return and, in many ways, this theory goes right to the heart of what a good financial adviser does. It is not about the latest fashionable investment theory or the return of an old favourite, it is about knowing your client, working with your client over the long term and building a savings and investment portfolio that matches the client’s level of risk and financial goals. Theories may come and go and that is a fundamental which will never change.

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