It’s a sad fact that many people who are professionals or start their own businesses tend to neglect one of the basic rules of any good retirement plan: diversification.
Why would a person who is often well educated not take advantage of the opportunity to diversify?
Having spoken to a range of people in this category, I have pinpointed three recurring reasons why they don’t invest in the same manner as those in a corporate environment who are forced to ‘diversify’.
- Keeping up with the ‘Joneses’. As salaries increase and people become more successful, they make lifestyle changes, spending more to maintain that increased lifestyle, but then neglecting to do the same for their futures to maintain those changes: they simply don’t increase their savings contributions.
- Preferring the DIY approach. The most common mistake is choosing one asset class. It seems that at times when markets are in a bull phase everyone is a specialist. The most recent asset class which experienced exceptional growth was residential property. When you study residential property as an asset class you will find that it has many pitfalls and it compares to fixed income when you consider investment returns.
- Forgetting about tax. They don’t think about tax ramifications later, which means they don’t utilise the most tax efficient investment vehicles when they do invest.
Getting it right
So, how can you avoid these same pitfalls? Follow these golden rules when investing:
- Make sure that your financial planner has the necessary qualifications, experience and processes to provide you with the appropriate solutions which are backed up with service.
- Don’t be greedy. There are only two emotions that drive investment decisions – fear and greed. Avoid investments that sound too good to be true as they probably are.
- The only way to accurately predict an investment return is by having the right mix of different asset classes and diversifying across all, both locally and internationally.
- Avoid having too much money in cash investments earning interest. Over the last ten years if you were invested in cash, the buying power of your investment would have been negative – in other words, inflation eats away the purchasing power of your money.
- Make use of any tax relief provided by SARS. Make full use of contributions to Retirement Annuities and use unit trust-based investment strategies within the investment vehicle.
- If you are investing in an endowment policy make sure that it’s appropriate according to your taxable income and use unit trust based investment strategies within the vehicle.
So why am I suggesting that people who work in a corporate environment do not fall into the same trap or make the same mistakes as those who work for themselves? It’s simple.
- They are forced to contribute to tax efficient retirement savings
- They do not take as much risk as a person in their own business
- They know they’re not an expert.
Remember this fact: 70% of all SMEs fail.
While this should in no way deter you from starting a business (South Africa needs as many entrepreneurs as possible), keep in mind that in the future the income from your business (which you currently use to pay for your lifestyle now) has to be replaced by income from ‘lifetime’ investments.
If all of your eggs are in your business, are you necessarily protecting your future? Make sure that you are saving enough so that you can stop work one day and protect yourself against catastrophe by having the necessary insurances in place.