“Smart money” is used to describe institutional or professional investors, by default that makes the rest of us the “not so smart money”.   What seems to distinguish the “smart” from the “not so smart” is the degree of emotional influence on decision making, particularly when it comes to understanding risk.

I vividly recall taking a client to an investment feedback presentation at which the manager referred to a recent loss as “only numbers”.  Needless to say the loss suffered by the client was not only numbers to him, but his hard earned cash going down the drain.  Of-course what the manager was trying to say is that the loss was only temporary as a result of a fall in prices, which would recover given time; versus permanent loss of capital when you money is really gone.

When measuring risk the financial services industry confuses investors by treating temporary and permanent loss as one and the same.  Surely risk refers to the probability of losing your money?  If that is so and the manager is correct, that providing you have not overpaid, a fall in share price is only temporary; could one argue that the stock market is risk free?    I can just imagine the Regulator having a coronary reading this, but it all depends on how you define risk and of course the price you paid, which is the real risk and why we spend so much time debating the value of markets.

There are really only three ways to lose your money 1) Ponzi Scheme; I am sure most readers are familiar with this term 2) Pay too Much for a share; you get price and you get value and very often these two disconnect from each other, with the market price either well above or below the underlying intrinsic value, if you overpay you will lose your money 3) Invest in a business, which goes bankrupt; this happens, which is why it makes sense to invest in a diversified portfolio.

Unfortunately many investors also lose their money through selling or switching during periods of temporary loss when influenced by their emotions and this is why the financial services industry mistakenly defines risk as volatility of return, when it is really the investor’s behaviour that is the risk.

Irrational investor behaviour is a very real risk, so be honest with yourself and your advisor when determining your risk appetite.

 

Mark Williams
Mcomm, CFP®, HdipTax
T. 021-851 3746
E. service@synfin.co.za

 

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What distinguishes ‘smart money’ from ‘not so smart money’?