The field of investments is one that is complex and confusing to most people who are not directly involved in the industry. It is a minefield of convoluted products, offering all manner of bells and whistles, market risks such as Steinhoff and African Bank, political meddling in the form of ill-conceived government policies, all spiced with a liberal pinch of incompetent advice.
So how do you decide where and how to invest your hard-earned money? The aim of this article is to demystify the process and help you avoid the mines mentioned above.
There are three major points that you must consider before starting an investment. These are:
- Market risk
- Product risk
- Investment risk
This is related to the general risk of being invested in the market as a whole. This relates to things like recessions and financial crises. One needs to consider broader macro-economic factors here, and simply put, you as the individual have no control over this type of risk. The best you can do is seek markets which are less risky.
For example, the South African economy is currently faced with several significant risks, the most pertinent of which are the looming threat of land expropriation without compensation, the mining charter, and a decline in the purchasing power of the middle class. One way to avoid this risk to is simply invest in a foreign market such as the USA, thus divesting yourself from the risks facing the South African investment landscape. The US economy is not without its own risks, such as recession, threats of trade war etc. These need to be evaluated accordingly.
The bottom line of market risk is that it will always exist. Markets do however trend upwards over time and thus investing for the long term should help to ameliorate this risk.
This is the risk which I personally find most dangerous. It is investing in the wrong financial products, which are either not suitable for your personal circumstances (due to bad advice) or are simply outdated and not suitable for anyone.
A prime example of this type of risk would be investing in an endowment rather than a unit trust. Recently I came across a new client who had been investing R2000 per month into an endowment for a period of 16 years. The total contributions came to R384 000. The underlying fund in the endowment had returned over 10% per year for the same period and thus it was expected that after fees the investor should have been sitting on between R800 000 - R1 million in the endowment. However, her total asset value was less than R290 000. Less than she had been contributing for all those years! The reason for the absolutely shocking performance was due to the fact that an endowment is taxed at 30% annually, regardless of the marginal tax rate of the individual investor. Who in this case, normally pays zero tax, as she falls below the threshold and is a pensioner.
Thus due to poor advice and by placing a client in an unsuitable structure, the outcome has been catastrophic.
Many people take their advisors at their word and are placed in unsuitable investment products, typically due to the incentives offered to advisors by life assurance companies, for placing clients in these investment products.
A simple rule of thumb to avoid this is by realising that if you pay less than an effective rate of 30% income tax, you should be in a unit trust, not an endowment.
Retirement annuities are another culprit of this, particularly those which offer all manner of bonusses for staying invested for a long period of time, etc. Simpler is better in this regard. Find something that does not tie you in and has a low fee structure.
Every investor is different. As a result we all have different objectives and needs. For this reason investors can be classified by their risk tolerance, which simply put is how long they can afford to stay invested for. Conservative investors have a time horizon of less than 12 months or require income from their capital, while aggressive investors can leave their capital for 10 years without needing to touch it.
It is very important that you as an investor understand what your time horizon and risk tolerance is. Many people want to earn 15% per year on their portfolio, but don’t understand that this comes with significant volatility and quite often, years of negative portfolio returns. Most cannot stomach this.
The easiest way to set up a portfolio correctly is by categorising when you will need your money by. Thus you can create baskets of saving for the short term, medium term and long term, allowing you to have different investment risk profiles within your portfolio.
If you understand these three basic points, then you will manage to avoid 90% of the mines in the investment universe. My role as a wealth manager is to help my clients understand these risks and then further optimise their portfolios to be tailored uniquely to them. Currently we perceive the South African market to be particularly risky, and as such recommend investing offshore. Please complete the form below if you would like to set up an obligation-free consultation.
Ricki specializes in the field of wealth management with a focus on holistic financial planning. He has a keen interest in the investment fields of property, technology, precious metals and cryptocurrencies. Ricki also holds a Masters degree in Science from the University of Stellenbosch.
Important Risk Notice:
Crypto Currencies are not defined as securities in terms of the Financial Markets Act, 2012 (Act No. 19 of 2012). The regulatory standards that apply to the trading of securities, therefore, do not apply to virtual currencies. Because virtual currencies are not regulated, users are not protected and are at the risk of losing money. Transactions are also irreversible. The price of virtual currencies is based on investor sentiment and can rise rapidly, thus attracting investors looking for very high returns from investments. However, the prices of virtual currencies tend to be very volatile and can drop as quickly as they rise. This may encourage speculative behaviour, which in turn spurs more volatility. Financial risks are, therefore, limitless and claims cannot be made for such losses.