Whether you’re a passive investor, a co-pilot or a pilot, there are three key principles that universally apply to all investors, and which you should take into consideration before choosing to invest:
What are your objectives? • What is your time horizon? • What is your risk tolerance?
Understanding your objectives
“Entrepreneurs in particular are focused on growing their own businesses, and they generally know that they can get the best return on their investment in their own companies,” says Warren Ingram, investment expert and founder of Galileo Capital.
“For example, if your company is experiencing 40% year-on-year growth, that’s a much higher return than you’d make investing your money elsewhere. And of course you’re putting all your cash back into the business because you need it for growth and cash flow purposes.”
On the other hand, this also means that all your eggs are literally in one basket. Having some money in outside investments provides a safety net.
“Whether you need a safety net or not often relates to your time frame,” says Ingram. “Objectives and time horizons influence each other.”
The time horizon factor
A 30-year-old entrepreneur whose business is growing and generating cash is in a very different position to a 55-year-old entrepreneur.
“Younger entrepreneurs have 20 or 30 years before they need access to the funds they’ve invested and grown in their businesses,” explains Ingram.
“They can afford to wait for the higher returns. Older entrepreneurs on the other hand might be looking to exit the company within a few years. Your time horizon should be aligned to your objective. Keeping your cash in your business will give you higher returns (provided the business continues to grow), but the investment takes time. If you need to see returns sooner, it might make more sense to invest elsewhere.”
Tolerance for risk is an incredibly personal choice.
“Many entrepreneurs like to be in control of their money. If it’s in their business, they have more control over it than if it’s invested in the stock market, for example,” says Ingram.
“As the business grows and they choose to diversify however, they might start investing in the market. The problem comes when the market dips. A classic case is an entrepreneur who sees the market dip, and immediately pulls their money out and puts it back into the business. All they’ve done is lose money.
“Investing is about patience. Markets dip, and then they grow. You need long-term objectives and patience. We often find that entrepreneurs look at their business, and compare their 40% growth to the market’s 20% growth. They’ll choose their business every time. What you need to remember is that nothing gives you 20% year after year.
“Early business growth is usually enormous — your return on investment is high, and your company needs cash to grow. It doesn’t make sense to put your money anywhere else. But once that initial large growth is over and you have surplus cash to invest, be patient with that investment. Don’t have quick, gut reactions when the market turns — it will come back.”
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The value of a plan
Ingram believes that having a plan in place is the best way to ensure you’re investing your money wisely, whether that’s in your business or elsewhere.
“We’re an entrepreneurial company. In our early years we also only invested in ourselves; and each time we launch a new business, that’s a brand new investment again. We understand how entrepreneurs think because we think in the same way. This means we know there’s no point in trying to convince an entrepreneur to not invest in themselves when their returns are higher than the market.
“But, we will always recommend having a plan. Set objectives for yourself. Plan to invest all surplus cash into your business for the next five years, and thereafter to diversify and invest 50% into the market, or buy property. You generally need 1 000 days (or three years) for any investment to see stable growth, so while your goals are variable, have patience.”
“We categorise pilots as investors who want to be able to touch, see, feel and control their investments. They might not have all their money in their businesses, but they’re not just handing it over to a broker either.
“We would recommend direct shares such as ETFs (exchange traded funds) as they’re commodity based, as well as investing in physical property, such as commercial buildings and houses that can generate rent.”
Next, Ingram recommends going back to the objectives. “Does the investment need to generate income or not? If it does, it makes sense to not put every cent into shares, but to invest in property as well. You then need to weight up all the risks associated with each investment.
“For example, we often see an investor buy the building that their offices are housed in. This does well, and so they decide to purchase a second property. However, now you’re not your own tenant. What happens when your tenants can’t pay? All your money is now a concentrated risk in one asset. Yes, you can see it, touch it and control it, but it’s still a risk.
“Instead, we advise spreading that risk out. Purchase smaller properties across industrial, retail and residential sectors, or buy shares in a listed property company or property ETFs. That way, for one trading cost you’re spreading your risk across multiple properties.”
If you believe you’re a pilot and you want to be in control of your investments, Ingram recommends you start with a small percentage of your funds and play with them. “Learn to invest by doing,” he says.
“You’ll either be successful or each investment decision will bomb. Rather find out which before you invest everything.”
“You also need to be honest with yourself and pay attention to the market. If you lose 10% and the market loses 30%, you’re doing well. On the other hand, if the market does 20% and you only do 5%, there’s a problem. You can’t invest in a bubble. You need to pay attention to what’s happening around you.”
One final piece of advice: Just because you’ve successfully started and run a business does not mean you’re necessarily a good investor. “The two don’t correlate,” warns Ingram. “So start slow.”
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Co-pilots typically want to manage their own investments, but they want to do so to a structured plan.
“We find that many investors come to us for advice and help with putting an investment plan together, but they still want to manage their own portfolios. They want to know the obvious things to avoid, and be given some broad advice,” says Ingram.
“Then there are investors who invest a percentage of their funds with us, and keep a percentage to play with themselves. They’re comfortable knowing they have a safety net, but also some control over their personal investments.”
According to Ingram, whether an investor is a pilot or co-pilot isn’t always linked to financial acumen.
“Some people will migrate between the three groups over the course of their lifetime, and we often find that financially sophisticated entrepreneurs who don’t have the expertise or experience in investing will actually be co-pilots or even passive investors. It’s really down to what you feel comfortable with in terms of how you structure your investments.”
The passive investor
If you’re going to be a passive investor who relies on an advisor, there are a few things you need to take into consideration.
First, understand the costs involved. “If you make use of an advisor, they must disclose their costs,” advises Ingram.
“Anything more than 2,5% a year is expensive. The closer you get to 1%, the better your deal. Always ask an advisor how much they charge.”
Second, understand the efficiency of your various options. “Do you want to invest in ETFs, unit trusts, a range of shares or a managed share portfolio that you can track? Entrepreneurs don’t tend to like retirement annuities (RAs) because they can’t access them, and they tend to want liquidity in case they need to access cash. Always consider what you want from your investment before you make any decisions.”
Ingram also advises you to take the time to understand what you’re investing in. “How are shares performing versus unit trusts, for example,” he says.
“How are either doing within context? You need to look at the investment over five to ten years, and then compare it to the market. If a particular fund or share is matching the market, then it’s reasonably efficient.
“ETFs will always be efficient because you’re essentially buying the most efficient funds in the market, and the JSE, or any traded environment, is regulated, and therefore a safer investment.
“Also be wary of investments that are too good to be true, with extremely high promised returns. Currently, the best return you can expect is 7,5% over inflation. That’s the norm. Investments that are much higher than that are probably too good to be true.”
Ingram also advises passive investors to stay away from complex investments. “You should understand your investment within a 15 to 30 minute conversation. If you can’t, walk away. It’s too complex, and likely to be a pyramid scheme. Always take the time to ask questions and make sure you understand what you’re investing your money in.”
Getting your will in order
Most of us don’t like thinking about the fact that we’re not infallible, but the reality is that we aren’t and we should have proper plans in place should something unforeseen happen.
“As the year begins, the first thing you should be thinking about is your succession plan,” advises Warren Ingram.
“You don’t necessarily need a trust, but at the very least you should take stock once a year: What’s changed? How does this affect your family and business? How does it affect your will?”
According to Ingram, the beginning of the year is a great time to evaluate a few things:
- Are your spouse and children looked after in the event of your death?
- What happens to your business?
- How will it get sold to the right buyer, and at what value?
- Is there a buy/sell agreement in place?
- How is the business valuation done, and has anything changed in the last year that will affect this evaluation?
“This might not be something we enjoy focusing on, but it’s essential,” says Ingram. “You’ve built a business to take care of your future and that of your family, so make sure your will and succession plan are in place.”