“Pessimism is better than optimism, as it is realistic,” says who?

For example, advice is dished out on how to invest if South Africa were to collapse. This train of thought is shared far and wide. We are put under pressure to protect investors against such an eventuality.

However, if I would say SA equities are cheap, then the response is, “There he goes again, the eternal optimist.” Or some commentators would say he is probably paid to write such optimistic nonsense. In both cases, the expected outcome (good or bad) is uncertain, but the pessimistic view expects some action.

Morgan Housel says no matter how the economy is performing, there will always be people saying the next recession is around the corner or hyperinflation is imminent, or the exchange rate is on the brink of collapse.

Often, it’s the pessimistic commentators who are quoted, and if one happened to get a forecast right sometime in the past, that person is considered to have supreme wisdom. Pessimism simply sounds so much smarter and more possible than optimism.

Perhaps the popularity of a pessimistic view has to do with the pain associated with a financial loss. Research has shown that the ‘pain’ felt by an investor when their investments go down by 10%, is double the ‘pleasure’ derived from investment growth by the same rate.

Furthermore, risk management is a feature of the financial industry, where minimising potential losses is often prioritised over maximising potential gains.

It gets even worse. If I invest my clients’ funds in a low-equity balanced fund and the market tumbles I’m relieved, as the clients’ investments have declined less than those of investors in equity-only funds. However, the clients’ funds are worth less too, and to rectify this I must ‘hope’ for a stronger market, not that I was right about the market being on the brink of collapse.

Investors don’t want to be reminded or warned by their adviser that their investments may go down from time to time, as the adviser should know how to protect their investments against dips. However, when predicted by some ‘expert’ broadcasting it in bold print in a newsletter, the adviser is confronted with it.

After all, it’s not that difficult to be right about the possibility of a market fall. Almost every year, the US S&P 500 experiences a dip of 10% or more, and every four to five years a decline of more than 20%.

However, I have always benefited by the idea that equities are rising most of the time. I know I shouldn’t be naively optimistic, and sometimes it is necessary to warn that markets or particular shares have become too expensive.

Why do I say so? Since 1995, the S&P 500 has risen by 630% and the JSE All Share Index by 210% in US dollar terms – despite the major market declines in 2003, 2008 and 2020.

So on balance, we need to remember that the world is becoming a better place decade after decade, and likewise, equity investments are increasing in value. Obviously, we want to avoid major declines, but a bigger risk is losing unrealised gains when investors sit on the sidelines when the markets go up.

In general, although some prudence and risk management are required in the financial industry, the allure of pessimism may prove detrimental if it leads to an overly negative outlook. This may result in too conservative investment portfolios and investors losing out as they don’t have adequate exposure to markets that are rising more often than falling.