Cash Club: The risky business of ETF investing

Is the equity market risky as an investment or are we risky as investors? 2020 delivered on every worst-case scenario we hypothesised about and presented it to us in a short space of time.

This year we got to experience, amongst other things, a:

Market crash
Market recovery (still uncertain)
Full or partial loss of income (our own or that of family and friends)

If risk occupies the space between our expectations and reality, then the question we really should be asking ourselves when considering an investment, is “What do I expect from this investment?”. The answer might change the way we think about risk.

In March when the market crashed, my TFSA portfolio (also known as my Tax-Free Retirement Account) was down and some ETFs were worse hit than others. To stay calm I asked “what do I expect from my ETFs?” and the answer to was, “to mimic their respective indices”, which they were doing.

During the crash, a question I received frequently was “my portfolio is losing so much, what do I do?”. Before I answered I asked, “What did you expect from your ETFs?” To which the answer always came back, for them to grow in value”. The problem with that statement is that it reduces an ETF down to price and not what it really is, which is just a reflection of an index. At any point in time, you’re running the risk of not getting what you expect if you reduce an ETF down to price. In my opinion ETFs—especially vanilla ETFs—aren’t risky. It’s the investor’s expectations that are risky. The biggest risk to an investment is the investor.

On dealing with market risk

In my opinion, to fully accept market risk means to remain at ease for as long as the ETF mimics the index for the duration of the investment. The price in the short term doesn’t matter much until I hit retirement. Many people understand that ETFs and TFSAs (equity markets) are long-term investments, but they haven’t fully accepted the time horizon. When you ask anyone who wanted to sell during the crash if they would sell if the same ETF was up by the same percentage points, the answer is almost always no – because it’s not time yet. If that’s the case, shouldn’t a lower price mean getting more for your buck? Not unless you have fully accepted the risk.

Understanding fear

“Fear forces us to focus our attention on the object of our fear such that we end up creating the very experience we are fearing.” – Mark Douglas.

We merely understand and acknowledge the existence of market volatility risk without accepting it. This creates a fear of “losing” money, causing us to put an inordinate amount of attention on “red” days in our investment duration. This fear makes us susceptible to investing errors such as selling an investment too early, completely ignoring our own time horizon. Creating the very experience we are fearing.

The solution I always recommend is to not login to your account unless you’re buying. The less you view your account, the less the “red” days will affect you in any way.

Njabulo Nsibande is a Just One Lap user-turned-contributor and a founding member of an investment club. His “Cash Club” blog details his experiences balancing the financial obligations of a young parent with his investment aspirations.