Why the fear of missing out is a bad investment strategy

Cryptocurrency wallet.[Getty Images]

Kenyan investors have a long history of chasing the next big opportunity. The pattern is often driven less by a considered investment plan than by FOMO (the Fear of Missing Out).

One day, everyone is investing in quail farming or plots of land in Kajiado. The next, it is cryptocurrency and Bitcoin. Then come  Real Estate Investment Trusts (REITs) or dollar hedging, followed by online forex trading. The asset class may change, but the behaviour is familiar

Once an investment captures the public imagination and stories of attractive returns begin circulating, many investors rush in, often before fully understanding what they are buying.

That does not make any of these investments inherently bad. The problem is investing in them simply because everybody else appears to be making money.

A good investment decision should begin with a much simpler question. What am I investing for?

That question forces an investor to look beyond the headline return and consider three things that should guide almost every investment decision.

First, understand where your money is going. Before putting money into any investment, you should understand what you are buying, how it generates returns, what risks it carries, and under what circumstances you could lose money.

Investors today have far more options than they did a decade ago. There are money market funds, fixed income funds, balanced funds, equity funds, REITS and special funds, among others. They do different things and carry different levels of risk.

A money market fund, for example, should not be judged by the same standards as an equity or special fund. One may give you easier access to your money and greater capital stability.

Another may fluctuate more in the short term but offer greater potential for capital growth.

Instead of simply asking which fund is giving the highest return, ask what the fund invests in, how it makes money, what could cause you to lose money and whether it suits what you are trying to achieve.

Secondly, consider liquidity, and this is where many investors get caught out. How soon will you need your money back? If you may need your money next month, say to pay school fees, your choices are different from those of someone who can leave their money invested for five or ten years.

An investment can be perfectly sound and still be wrong for you. If the money is intended for an emergency fund or business working capital, access to that money matters.

 On the other hand, money that you do not need immediately can generally afford a longer investment horizon.

Time is one of the most powerful advantages an investor has. The longer your investment horizon, the more room you generally have to ride out short-term market movements and pursue capital growth. It also gives compounding more time to work.

Finally, you must understand the relationship between risk and returns.  While everyone wants high returns, few people are enthusiastic about the risk that usually accompanies them. Yet the two can’t be separated.

Higher potential generally comes with greater uncertainty. An investor attracted by a double-digit return should also ask what risks are being taken to generate it.

For some investors, protecting the principal is the most important consideration. They may be better suited to investments that prioritise capital preservation and relatively stable returns.

Others, particularly those with longer time horizons, may be comfortable accepting market fluctuations in pursuit of greater capital growth.

Neither approach is inherently superior. What matters is whether the level of risk matches your circumstances and ability to absorb losses.

This is also why diversification matters. Building wealth is rarely about finding one investment and putting everything into it. A sensible portfolio can hold different assets for different needs, including liquidity, income, capital preservation and long-term growth.

The next investment craze will inevitably come. There will be stories of people making extraordinary returns, and there will be the temptation to jump in before it is too late.

Before you do, ask yourself three questions: Do I understand what I am investing in? When will I need my money back? And how much risk am I willing and able to take?

If you cannot answer those questions, the return being advertised should be the least of your concerns.

FOMO may be a powerful reason to act, but it is a terrible reason to invest.

The writer is the Old Mutual Investment Group Head of Business Development, Retail and Private Wealth.