We are often told that when you buy a share, or some other investment that invests in shares, you have to just forget about it and let it grow over time. There is a lot of truth in this advice because shares as an asset class do increase in value over a longer period of time. There are, however, three very important points to consider with a view to reducing your risk and enhancing your returns over time.
The first point to consider is the concentration of your share investment. If you or your fund manager invests in only one or two shares, and one of those shares underperforms for whatever reason, you will have a very unfavourable return on your portfolio. So, if you bought these shares while they were doing well and locked them away, you would not notice a change in the environment that could potentially have a negative impact on your shares, and a share that once was a star, might turn into a dog. We have seen numerous examples of this, and just looking at the list of companies that currently dominate the world stage, compared to the companies that dominated twenty years ago, tells you this story. If, on the other hand, you have a portfolio or fund in which you have a variety of shares, the impact of one or two negative performances will not be so severe. The lesson to take away from this is that the more concentrated your investment, the more you need to pay attention.
The second point to consider is the impact of better returns on your portfolio over time. This is a point that invites a lot of argument in the “active versus passive” debate. If you decide to just invest in the broader market like the JSE All Share Index, the main driver of your investment performance will be the asset class as a whole, and not much thought has to go into the quality of the individual companies that make up that asset class. So if one or three of the companies in the Index should go out of business, you will still earn the average return of the remaining companies. If, however, you take a more active approach to the management of your portfolio, and not just invest in the Index, you can theoretically avoid those bad companies and concentrate more on the winners, resulting in a better return over time. It has been proven that it is not easy to outperform the Index over time and that is why a lot of investors decide to just invest in the Index; which will require no work from their side and also costs less when they use fund managers. But there are some fund managers that do outperform the Index over time, and the result can be quite profound. If, for example, you manage to outperform the Index by 1% over time, the compounding effect of this outperformance will be as follows, simplified to make it easy to understand: in the case of an investment of R1 million, your outperformance will be R101 000 after ten years; R249 000 after twenty years; and R441 000 after thirty years.
The third point we need to understand, is that combining the two previous points can result in a “Goldilocks portfolio”; where the number of shares are just right. If we have a portfolio where there are just the right number of shares to decrease the risk of a bad one impacting the returns too much; but time and compounding will do its work with a good one big enough to have a noticeable impact on the performance. Thus, at the end of the day, it is worth your while to pay attention to your investments. If you have a longer-term portfolio where you see a 1% or 2% average outperformance, in the good years and the bad years, remember that underneath it all your portfolio risk is less over the shorter term and over the longer term these small gains will pack a big punch.