Investing

We have talked about the difference between investing directly in shares versus investing via a unit trust fund before, but there is still a lot of confusion out there. So let us summarize the differences between the two as follows:

Direct share investment

This type of investment is ideal for traders who want to buy and sell shares on a regular basis; or investors who have a specific interest in a particular company and want to hold the shares for the longer term. There is a third group of investors, who use a direct share portfolio to increase the possibility of higher returns on their overall equity investments by investing in smaller, higher-risk companies. This naturally also increases the risk of getting it wrong and losing money.

Unit trust investments

This type of investment is ideal for people who do not want to be actively buying and selling shares.

Using your own stockbroker vs unit trusts

There are thousands of companies to invest in worldwide; some of these companies will thrive over time and some will go bust. When you decide to buy and sell shares directly, you have to do a lot of research to understand the company you want to invest in and then continuously monitor that company to know when you have to sell again. Some people might argue that they would ask a stockbroking company to make these decisions for them but that would mean they are simply creating their own unit trust fund. Asking an investment professional to buy and sell shares on your behalf is exactly what you do when you invest in a unit trust fund.

We have also noticed that very few stockbroking companies actively buy and sell shares in the discretionary portfolios they manage for clients. They adhere to a buy-and-hold philosophy and only buy when there is a new cash inflow. Unit trust managers are much more focused on actively managing the collective funds under their care and have to make daily decisions on which new shares to buy and which to sell because there is a constant inflow of new cash and outflow of old cash. We have also found that the amount of expertise in the fund management houses exceeds those of the general stockbroker and depending on the size of your direct equity portfolio you might get a stockbroker who lacks the proper experience.

Cost is another issue people raise when comparing the two. It has to be understood that if you ask a stockbroker to manage a direct portfolio for you, he will charge you a fee which is often not much less than the fees charged for investing in an equity unit trust fund. At JWR we do offer a service managing direct share portfolios for clients but we make it clear that we do not actively trade these portfolios, but rather engage with the client who has an interest in owning direct shares. Because we have regular interaction with the fund managers of the unit trusts we invest in, we tend to buy or sell shares on their recommendation.

In conclusion

At JWR we prefer to manage our clients’ portfolios by investing in unit trusts. We feel comfortable with their expertise and their dedication to managing the funds for the benefit of their investors and we encourage clients to have direct share portfolios only if they fall into one of the categories described at the beginning of this letter.

When investing in shares, a lot of people believe that you only need to buy those of a big blue-chip company and hold on to them for ever. This might have been a good investment philosophy a few decades ago but things have changed in the investment world. Back then you were limited to a few investment instruments like policies, retirement annuities, and of course a direct holding in shares. Buying shares was a cumbersome process and you ended up holding a piece of paper called a share certificate. If you wanted to sell the shares again, you had to mail back the certificate and a sales order before you could receive your money. Subjected to this unsophisticated process a lot of people believed it was just too much of a hassle to sell shares so they simply held on to them.

Today shares can be bought and sold online in a matter of seconds and we have instruments like ETFs and unit trusts which make the process of investing very fast and efficient. With access to the internet we receive information about changes in the economy and developments at companies instantly, making it much easier for investors to decide whether to buy or sell shares.

This new trading environment does not necessarily mean that the old buy-and-hold philosophy can no longer be used to great effect, but we have to at least monitor the shares we hold to make sure they are still relevant. Take, for example, an old favourite called British American Tobacco (BAT). If you bought BAT about 9 years ago, your return would have been 217% (24% per annum) plus you would have received good dividends. If you bought BAT 4 years ago, your return would have been 0%, but you would still have received the dividend. If, however, you bought Anglo American 9 years ago, your return would have been between 0% and 79% (9% per annum) – with wild swings – over the 9 years.

So, it becomes clear that the new environment created by the internet and the advances in the IT sector has changed the general investment philosophy of buy-and-hold to one of buy-and-monitor.

We will keep this newsletter before the long weekend short and hopefully sweet.
Everywhere we go, we hear investors complain about the bad returns on their portfolios and their consequent anxiety. When we engage in conversation, it usually becomes clear that they do one of two things to cause their anxiety, namely:

• They compare their returns to a specific other investment that is doing very well at the moment; or
• They look only at their returns over the last three months; ignoring the longer term and the performance of the various components of their portfolios.

Fact is, there will always be some investment that does well at any given time. Do not consider only the current return on that investment, but also the risk you would be taking if all your money were invested in that one investment. It is only natural to feel nervous when some of your investments are not performing well, but there will always be good times and bad times.

One of the most important aspects of constructing and managing a successful long-term investment portfolio is called Strategic Asset Allocation (SAA). SAA is the strategy for matching your cash flow requirements to the appropriate asset class. Money you will need in the next year or two will be placed in cash and money you will need in 10 years’ time should be invested in shares. So, when you evaluate investment performance, always look at the performance of each of the building blocks of your investment individually.

Cash has been king over the past three months, so if you have had some bills to pay, you should have used the cash to pay the bills and left the shares alone. But, when you have to replace your car in 5 years’ time, the shares that are showing a negative return now should provide you with an inflation-beating return then.

• They compare their returns to a specific other investment that is doing very well at the moment; or
• They look only at their returns over the last three months; ignoring the longer term and the performance of the various components of their portfolios.

Fact is, there will always be some investment that does well at any given time. Do not consider only the current return on that investment, but also the risk you would be taking if all your money were invested in that one investment. It is only natural to feel nervous when some of your investments are not performing well, but there will always be good times and bad times.

One of the most important aspects of constructing and managing a successful long-term investment portfolio is called Strategic Asset Allocation (SAA). SAA is the strategy for matching your cash flow requirements to the appropriate asset class. Money you will need in the next year or two will be placed in cash and money you will need in 10 years’ time should be invested in shares. So, when you evaluate investment performance, always look at the performance of each of the building blocks of your investment individually.

Cash has been king over the past three months, so if you have had some bills to pay, you should have used the cash to pay the bills and left the shares alone. But, when you have to replace your car in 5 years’ time, the shares that are showing a negative return now should provide you with an inflation-beating return then.

These are volatile times and a lot of skeletons are tumbling out of closets. It is a time of reckoning for overconfident investors, fund managers and companies that laid big bets on a few assets or strategies and are now losing more money than they will be able to recoup for a long time, if at all. Just take a moment to mourn the Bitcoin bulls, the Steinhoff disciples, the Resilient ravers and the Brexit punters. If you invested heavily in any of those assets – or assets linked to them – you would have lost at least 50% of your investment over the past few months. Which means you would now have to earn a 100% return just to get back to where you were.

 

There may have been times these past years when you thought the wheels were turning very slowly for you and you were being left behind. Your neighbours may have bought Bitcoin and doubled their money within a few months; or your friend may have invested in a property syndication and received a 10% return per month. Meanwhile your money was invested in a balanced portfolio of shares, bonds, property and cash and you received a return of only 9,22% per year for the past 7 years. You may have thought that this was just not good enough.

 

But, what you need to keep in mind is that there are two very important advantages that come with this prudent approach to investing: namely beating the cost of living, or inflation; and being able to sleep at night. If we look at the returns generated by various asset classes over the last 7 years, we see the following:

SA General Equities	9,44%
SA Resources	0%
SA Industrials	14%
SA Financials	15,45%
SA Property	12,55%
Cash	6,3%
SA Bonds	9,12%
Global General Equities	15,18%
SA Inflation	5,59%

So, if you invested R1 million 7 years ago, you would now have R1 854 023 in your balanced portfolio. R1 463 000 of this amount would cover only the increased price of goods and services caused by inflation, but you would still have a clean profit of R391 000. If you were very conservative and preferred to leave your money in a Money Market account, your clean profit would be only R70 673 and most of this would go to the taxman if not properly structured. The moral of the story is that you can generate proper returns without taking a lot of risk if you are a longer-term investor.

 

At the end of the day it is your mindset that will determine your financial well-being. Chances are that the person who bought Bitcoin or property syndications might have made it big the first time around, and even the second time – provided they got out in time – but their mindset is that of a gambler and we all know the casino always wins in the end.

We have been advising clients for more than 22 years and the saddest stories we encounter time and time again are the ones we call “riches to rags”. BizNews recently carried a very informative article by Mike Fannin, a financial advisor, in which he explains why being rich and being wealthy are two different things. He highlights the fact that a study conducted by the Williams Group wealth consultancy in the US shows that 70% of wealthy families lose their wealth by the second generation, and an even more astounding 90% by the third. We are of the old-school opinion that if you have not worked hard for every rand you’ve earned, you will not understand the value of money and squander it quickly and easily. Mike Fannin goes on to say that research done by Forbes has shown that only 22% of millennials demonstrate basic financial knowledge.

To illustrate the point, Mike gives the following examples: The rapper 50 Cent quickly earned a fortune of $155 million, but by July 2015 it was gone and he was bankrupt. Another young rap artist, MC Hammer, earned a $30 million fortune with his chart-topping hit songs in the 90s, but filed for bankruptcy six years later with debts of more than $13 million. Even Michael Jackson was in debt to the tune of $500 million when he died.

It all boils down to understanding value; whether of money, water, electricity, food, income security, or anything else. If a parent becomes very successful financially, it is his or her responsibility to educate the children about the value of that money. Warren Buffett once wrote that every time he was about to take a dollar out of his wallet, he understood that if he chose not to spend it at that moment, he could have two dollars in a very short period of time. So he always made sure that whatever he was going to spend his dollar on, would provide him with actual value.

People always say there is no such thing as a free lunch, but in investments there are two:

• the power of compound interest; and
• the benefits of diversification.

 

Compound interest is the central pillar of investment. It is why investment grows so well over the long term. Look at it this way: if you save R10 000 at a return of 6% and withdraw nothing, you start the second year with R10 600 and you earn interest on both your original R10 000 and on the interest earned in the previous year. In short, you earn more interest each year because your investment amount increases every year even though you do not make any additional investments. The compound interest gained on the initial amount of R10 000 may not seem significant, but when applied to larger figures the effect is substantial.

A good way to accumulate savings, is to sign a monthly debit order towards an investment when you start your first job. That way you become used to not having the money available to spend on other things. Even if you are already in your 30’s or 40’s, it is never too late to start saving for your retirement, but the younger you are when you start, the more you stand to benefit from compound interest and the less money you need to put away each month, compared to somebody starting to save in later years. It is all about allowing time for compound interest to make your money grow.