When it comes to investing, there are no experts who are able to give you short-term investment advice. No-one could have predicted 15 months ago when the rand collapsed and a new government was being formed, that the rand today would be under R8 to the dollar. Even more remarkable is the stock market, which, in the year from March 2009, has risen by over 50%.
Some years ago, the Nobel Prize for Economics was awarded to Harry Marcowitz, a psychologist whose theory confirmed the notion that if you are confused then you are probably thinking straight. He argued that under a classic model, decision-making is rational, but the reality is that people make decisions in an irrational way mainly because they do not like taking risks.
Apply Common Sense
As an investor, your thinking should be driven by fundamentals rather than sentiment. In order to achieve this, you need to:
- Define your needs
- Design better solutions to meet these needs
- Set realistic expectations for your investments
- Work hard to meet your expectations
Define your financial needs according to the time horizon in which you expect to need cash:
- For periods of up to one year
- Unanticipated needs
- For periods of one to three years
- Cash which you need, but for which you cannot commit to a date
- For periods longer than five years
- For your retirement, as long as it is at least five years away
- Money for no specific need
Define your risk aversion per category. Within each sub-portfolio you need to identify a conservative and also an aggressive class of the relevant assets. Then allocate the portfolio in each section according to your needs. Within each sub-portfolio, switch between underlying assets to take advantage of relative values.
It is important to understand the difference between a long-term investment and one where you are speculating. The concept of the greater the risk the greater the return, is nonsense. Often when you expose yourself to great risk, you end up losing all of the money you invested, so ensure that you understand what you are doing.
Choose the investment that meets your needs
- Cash or money markets. Cash or money markets are suitable only for short-term liquidity – they are not a good solution for the medium-term or long-term because they usually provide returns not much in excess of the rate of inflation. This is particularly relevant when you look at the after-tax return. A gross return of 7% at a 40% tax rate will give you 4,2% after tax.
- Bond markets. Providing a solution for medium-term investments, bond markets offer ultimate repayment of your capital and provide a fixed income stream. Currently, returns have reduced as interest rates have fallen.
- Stock markets. Stock markets rise over long periods of time as companies are continuously innovating, increasing efficiency, developing, building, acquiring. In other words, if you examine the long-term, 10 years and longer, over the last 70 years on a rolling 10-year period, equities have outperformed any other asset class.
- Derivatives. Any investment involving derivatives, such as futures and options or currency forwards are inherently speculative, and the implications of investing in them should be clearly understood.
Monitor your needs relative to the investment. Performances of each sub-portfolio should always be measured against a well-defined benchmark, i.e. liquid assets against a cash benchmark and long-term assets against an equity index.
Change the investment when your needs change
When meeting with your financial planner, your needs need to be clearly defined and your portfolio managed in accordance with your needs. Guidelines for performance behaviour can be set and, with a fair measure of confidence, will not be exceeded. These guidelines set correct expectations and therefore make life easier for you and your adviser.