Investment markets are not for the faint-hearted and, being volatile in nature, often requires investors to have nerves of steel especially in turbulent times. Before starting out your investment journey, it’s best to know what you could be in for. Here’s what to consider:
- Starting can be the hardest part
Those setting out their careers often find it difficult to visualise a retirement that could be 40 or more years away and, as a result, decide to delay funding for their retirement until later in life. It’s difficult to find motivation to save for such a distant goal especially on an entry-level income with competing priorities in the here and now. Many attest to feeling overwhelmed by the investment choices available, unsure how to start their investment journey and discomfited at the thought of seeking professional finance advice. While a combination of these factors may make it difficult to begin your investment journey, keep in mind that many service provider now provide minimum investment contributions of R500 per month which, together with online platform functionality, make it easy for first-time investors to begin their journey.
- Compound interest is powerful
Compound interest, or compounding interest, is interest calculated on the initial principal including all the accumulated interest – thereby creating a snowballing effect when it comes to accumulating wealth. Because of the power of compound interest, even an average saver can amass sizeable wealth over time. To make compound interest work for you, you will need some money to invest, an investment return that beats inflation, and time. Once you start investing (even if it’s a relatively small amount) you will continue to earn interest on your interest as time goes by – making time the most important part of the compounding equation.
- Delay creates a lost opportunity
Money has a time value meaning that the sooner you invest, the more time your money has to grow and generate investment returns. The longer you delay getting into the markets, the more you miss out on compounding returns – and you can never get this time back. Further, keep in mind that inflation erodes the value of cash over time and reduces its purchasing power in real terms. As such, the longer your money remains uninvested, the more it is at risk of losing value to inflation. In a nutshell, the longer you delay your investment journey, the longer it will take to reach your goals – and if you’re not sure of your goals, start anyway. Remember, no decision is a decision in itself.
- Having a game plan can help you stay the course
Research is clear that you’re more likely to stick to your investment strategy if you have a game plan in place, although it’s important to ensure that your investment strategy is aligned with your goals. For instance, putting money away each month to save for a deposit on a house in the medium-term will necessitate a different strategy than if saving towards retirement. Remember, investment goals need to be measurable, rational and in line with your lifestyle objectives while at the same time taking into account your personal propensity for risk, the returns you need in order to achieve your goals, and the length of time you intend investing for.
- Don’t look to time the markets
Trying to time the stock markets is a bit like jumping shopping aisles to find the shortest queue – only to get stuck at the till with the slowest teller whose with a faulty scanner. The reality of investment market performance shows that between 80% and 90% of all the returns realised on the stock exchange occur between 2% and 7% of the time. This means if you’re out of the market when stocks start to perform, your portfolio is destined for under-performance. Nobel laureate William Sharpe’s research found that market timers must be right an incredible 82% of the time just to match the returns realised by buy-and-hold investors, so avoid timing the markets and stay committed to time in the markets.
- Tax is inevitable
As an investor, you will want to save in the most tax-efficient manner by minimising the tax payable and maximising your tax benefits. Different tax structures apply to different investments and it is important to understand the tax implications of an investment before implementing. For instance, tax-free savings account premiums are not tax deductible, but the interest earned on the investment is tax exempt. On the other hand, premiums towards a retirement annuity are tax deductible subject to certain limits. While no tax is paid on the capital growth or income in an RA and no CGT is paid on disposal, tax does apply to any lump sums taken as a withdrawal or at retirement. Tax is payable on income generated from a unit trust investment and if you dispose of underlying shares you may be liable for CGT.
- Markets are volatile by nature
The market is driven by the supply of shares people want to sell and the demand for shares that people want to buy and, as such, is a complex system of investors making decisions about a wide range of investments. By their nature, investment markets are volatile and subject to short-term fluctuations – although, history is clear that investment markets are excellent for investors wanting to achieve real returns over time. Wars and conflicts, government fiscal policies, natural disasters or extreme weather, and technology disruptions are just a few things that can affect investment markets in the short-term. Having discipline and long-term investment goals will help you drown out the short-term market noise.
- Diversification is your friend
Diversification is a cornerstone of portfolio construction and is effectively a strategy that ensures that your invested funds are spread across a range of asset classes, currencies, geographical regions, industries, and sectors. As such, investors can spread their risk between local and offshore equities, local and overseas currencies, developed and emerging markets, as well as between various sectors such as mining, healthcare, energy, retail, technology, construction, and consumer goods. The underlying principle is that different assets perform differently under different market conditions and, by spreading your risk you can effectively protect yourself against losses incurred by one particular asset class or investment.
- Investors can be irrational
Mounds of research has uncovered evidence that rational behaviour is not that prevalent when it comes to investing because human emotions tend to take over the decision-making process. Emotions such as fear, greed and panic can lead investors to make knee-jerk decisions in response to short-term market fluctuations – often with detrimental effects to their investment portfolios. Investor emotions are driven by a range of biases such as over-confidence, loss aversion and mental accounting. Key to becoming a more rational investor is learning to identify your biases and to avoid them impacting your investment decisions. Emotional composure is key.
- There’s always risk
As an investor, it is essential to understand the relationship between risk and reward. The higher the relative risk of an investment, the larger the possible returns may be. For instance, cash is considered a low risk investment while equities present a higher level of risk. What is important to note is that risk is never completely absent and returns can never be guaranteed. For these reasons, it is important that each investor understand his own propensity for risk before investing. However, the reality is that if you want your capital to beat inflation, you’re going to have to take some investment risk. Finding the most appropriate level of risk for yourself involves balancing your portfolio, understanding your financial personality and giving consideration to your investment timeline.
- Every family has an ‘investment expert’
Mention the word ‘investing’ at any family get-together and you’re likely to be the recipient of unsolicited investment advice from the self-professed family expert. Whether it’s whisky, crypto, wind-farming, or collectibles, everyone seems to have an opinion on ‘the next big thing’, whereas the reality is that no one knows what the future holds. Many so-called ‘experts’ suffer from confirmation bias in that they only read material that supports their belief for the future – which only serves to give them more confidence and make them sound more convincing than their underlying knowledge of the investment environment supports.
- Fees matter
Investments come at a cost, and these fees are generally charged as an annualised percentage which includes investment management costs, advice charges and administration fees. Costs can significantly impact your investment returns and it is important to have full, upfront transparency of the fees you are being charged. When analysing your fees, it is important to determine the difference between upfront fees (such as a financial planning or implementation fees) and ongoing fees (such as advice and administration fees). Over time, investment fees can have a significant impact on your investment’s growth, so it is advisable to shop around for favourable, market-related fees. Having said that, bear in mind that an experienced financial adviser can add significant value by helping you set goals, structuring your investments, minimising your tax burden and regularly recalibrating your portfolio. His fees should be fully disclosed upfront and should appear separately on every statement.
Our advice is to partner with an independent, fee-based advisor who can help create a bespoke investment strategy that is unique to your circumstances.
Have a fantastic day.
Sue
