Investing

In the J.R.R. Tolkien story, The Lord of the Rings, there is one all-powerful ring that binds and rules the […]

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Sanlam recently published an article about currency performance and it might be of value to have a look at the results. Very few countries on earth, if any, exist in an economic bubble. For as long as we can remember, there has been trade between different regions and this will go on forever. Trade usually happens because you don’t have some specific product in your own region, or you can get something cheaper from another region than by producing it yourself. If we take South Africa as an example, we don’t have sufficient oil and depend on other oil-rich countries to supply us with what we need. We, on the other hand, have a lot of gold, platinum, iron ore and the like, which some other countries have a shortage of.

So why is the currency of one country worth more than another, and why is there a constant change in the exchange rate between different currencies? There are a few things that will determine the value of your currency and one of them is the strength and predictability of your economy. A currency is just a piece of paper issued by a country with a promise to honour a certain value attached to it at any given time. If you don’t trust a government to honour such a promise, you don’t accept their currency, or you demand some other form of insurance. South Africa has a very small economy with a volatile political history, so almost no other country will accept the rand as method of payment. The US$ on the other hand is the complete opposite.

A currency will strengthen or weaken against another due to a change in the level of trust between the countries, as well as the purchasing power of a currency. Inflation plays a big role in the purchasing power of a currency and we can use the following example: If you sell an SA apple worth R1 to the US for $1in year one for $1, you have established a 1/1 exchange rate between the rand and the dollar. If in year two workers demand a 6% increase in wages, the apple will cost you R1.06. If the buyer can get the same apple somewhere else for $1, you will get only $1 for something that cost you R1.06. The buyer is not prepared to pay for your inefficiencies.

If we look at the following spreadsheet, we can see the movement in currencies of different countries against the US$.

Over a five- and ten-year period, only the Swiss franc managed to strengthen against the US$ annually. The rand has weakened by 4.6% annually against the dollar over the last ten years. If we translate that into an investment, you will see that if you bought R100 000 worth of dollars ten years ago, you would now be able to sell the investment for R156 790. It is interesting to note that the average annual inflation rate in South Africa over the last ten years was 4.9%, which is basically the same as the rate of depreciation of the rand.

It is very important for investors to develop the right investment mentality. Some people will always tend to be too aggressive and take unnecessary chances. They have no patience and try to get rich quickly. We could say that this group of investors eat their porridge while it is too hot and get burned. Then we get the investors who never invest because they see a crash around every corner. This type of investor will always remain a spectator and will eventually have to eat their porridge cold, chilled by inflation. Lastly we get the porridge-just-right investor. This investor understands that investing is a battlefield where losing a battle is not important, as long as you win the war.

To win the war in the investment world you have to develop the right strategy and temperament. There are a few things you have to get right and here are three of them:

• Patience: You have to understand that investing is something you do over a lifetime. If you start investing early in life, you don’t have to be clever or lucky. Investing small amounts in a broad range of international companies will be enough to get you where you want to be, owing to the forces of time and compounding returns.
• Manage your fear and greed impulse: The later in life you start investing, the more you will have to rely on skill and luck to get you where you have to be. You will feel the urgency to share in the good times and avoid the bad times and that will increase your chances of emotional investing, with the potential of making big mistakes. For most investors, managing their emotions is the most difficult part of investing and that is where a professional money manager can save you from yourself.
• Match your investment to your cash flow: Understand that equities and cash are both risky, but just over different time periods. Due to the unpredictable nature of equities, they are risky to invest in over short periods of time but essential over longer periods. Due to the predictability of cash, it offers low risk over the shorter time periods but the lower returns will be eroded by costs, taxes and inflation over longer periods. If you always have enough cash available to prevent you from selling equities when equities are down, you will never have to incur a loss on your investments.

As you can see from the points above, very little skill is required. You can go a long way by just doing the basics right, without having to chop and change your portfolio over time. There is, however, one additional fundamental skill you have to learn due to the recent explosion in the availability of information. You have to learn how to cut out the noise. The media loves to make everything as dramatic as possible, resulting in impulsive behaviour that can impact your investments over the shorter term. Equities, especially, gets impacted a lot by news over the shorter term, and that is why you always have to ask yourself one basic question, “Will my equity holdings be worth more or less in seven years’ time if (whatever negative news you hear) comes to pass?” If the news will be immaterial seven years from now, you can ignore it, but if it will cause a fundamental long-term change, you have to do something.

There is something deep within us that wants to stay busy. We want to do something, even if that something doesn’t add any value. Often you will hear people say that they are just too busy to take anything else on. When you ask them what is keeping them so busy, however, it turns out that they are just extremely inefficient at doing whatever they are doing. This doesn’t mean that they will be less busy if you can teach them how to be more efficient, it only means that they will be able to do twice as many things in the same amount of time.

In the work environment, efficient people are the ones at the top of the food chain when it comes to being in demand. How fantastic is the feeling you get when you have to get something done and after dreading the potential struggle, the matter is sorted out in next to no time by a super-efficient person. Although there are some personality traits mixed into being efficient or not, a lot of it must be learned. To be efficient you have to be able to prioritize, delegate, focus and never procrastinate.

Investments can also be efficient or not. Cash is inherently inefficient. Cash will never try to find better ways to increase your returns. It will always be happy to stay on the couch and not run the risk of being run over by a car if it should venture outside, seeking new opportunities.

Equities, on the other hand, is a very efficient asset class. When investing in equities, you basically invest in companies. Companies live in a world where the pace is frantic. There is always a competitor trying to steal your lunch; or a technology making your business redundant; or even a politician forcing some crazy policy down your throat. But all of these potential hazards make the good companies rise to the top and cement a high level of efficiency into their DNA.

Look at it this way: if there is a stream starting high up in the mountain, you will always be able to have a drink in the rainy season, but in the dry season you might have to work harder to find some water. If you do some work and build a dam wall, you will ensure that you will always have some water to drink and that any excess in times of plenty doesn’t just run wastefully into the ocean. It makes sense to work hard, make some money and then work smart and let the money work for you!

A long, long time ago there was a gameshow called “Money or the box”. In this gameshow, contestants had to choose between taking a known amount of money, or choosing a sealed box in which there was a mystery prize of potential great value, or not. Some chose the money and when the box was opened, it showed that they could have won a car or some other high-value item. Other contestants with a higher tolerance for risk chose the box, but when the box was opened they got nothing, losing the guaranteed cash they could have won.

The question here is: what would you do under the same circumstances? We can take an extreme example and do this exercise with Bitcoin. If somebody offered you one Bitcoin today (currently worth $100 000) or $100 000 cash, what would you choose? Take note that analysts think that Bitcoin will range between $150 000 and $300 000 in 2025.

If we apply this train of thought to something closer to your current situation, we can take the returns you have earned on the S&P500 over the last two years. In 2023 the S&P500 returned 26% and for 2024 we stand at 30%. If we do the math, you will notice that your compounded return over two years has been close to 64%. This is exceptional. So now you have to decide weather you want to cash in at year-end, or stay invested hoping for another good year. Most conservative investors will take the cash and most risk takers will stay invested. The question is; what will be the right choice?

The short answer is that we do not know, but if we look at history, the answer may be somewhat surprising. The table below shows that there have been only three previous occasions with two consecutive years of 25%+ returns in the S&P500 since 1928, and in only one of those instances we saw a negative year following the two bumper years.

So if history repeats itself, you should stay invested because your odds are better, but this is not a gameshow and your financial health is on the line so we would consider the following compromise:

• As per our strategic asset allocation planning done for all clients, you will always be advised to have a portion of cash available for shorter term expenses. This would be an ideal time to make sure that that cash portion is topped up if it has been used during the year.
• If you envisage larger ad hoc expenses in the near future, like replacing a motor car or paying for tertiary education, sell some equity and hold the cash for these expenses.
• Get rid of expensive debt like credit cards and consider paying something into your access bond.

We would not advise you to take a binary approach to your longer-term equity investments. Stay invested with longer-term funds as far as possible. Over time, whatever happens in the next year or two, equities will bounce back and provide you with the inflation-beating returns you need to afford your chosen lifestyle. Just look at the longer-term graph of the S&P500, including all the disasters!

For money managers like ourselves, it is very frustrating to see people losing money because they are not heeding our advice. It must be the same for doctors when they see a patient dying of a heart attack after having pleaded with him or her over many years to please change an unhealthy lifestyle.

The opportunity cost of holding on to cash is enormous over time. If we look at the first graph, we can see that on average, you will lose 54% of your potential return if you stay in cash rather than investing it in shares over a five-year period.

If we look at the second graph, it shows us the difference in actual dollars between a cash and equity investment. Over twenty years the equity investment grew to four times the size of a cash investment.

These are stats based on averages. Investing is not a difficult thing to do but we all know what the problem is: procrastination! Here are some excuses for not converting your cash into a proper equity investment:

• I don’t have enough money: Wrong! You only need a few hundred rand per month to start investing into an equity unit trust or retirement fund.
•  It is too risky: Quite the opposite! You are guaranteed to lose money relative to equities over longer periods of time as the graphs above show you.
• It is not the right time, the market is too expensive at the moment: It will never be the right time. If you have a lump sum to invest, at least phase it in over a few months if you are really worried.
• I want to invest overseas but the rand is too weak: Currency is unpredictable. In 90% of the cases, if you get a stronger rand by waiting, you will have to pay more for the share you want to buy overseas.
• I am too young to start: Are you kidding me! Look at the graphs, the miracle of compounding returns will reward you generously for starting at birth.
• I will do it later: No! Just do it now.

The only other sensible thing to do with your excess cash is to pay off your bond. We would be okay with that but would issue the following warning: Don’t get addicted to debt! It is very easy to fall for all the easy credit available from banks and retailers but before you know it you get caught in a debt spiral. It would also be wise to not keep on upgrading your residential property by extending your bond. At some stage you have to either split your savings between bond repayment and equity investment, or be happy with your house the way it is and build your equity portfolio.