Investing

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:

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.