We would all like to think that we have an aggressive risk profile, until our investments start to lose value. That quickly turns an aggressive investor into a very conservative one.
By aiming for the stars, we often aim too high and then the saying, “the higher you fly, the harder you fall” comes into serious play.
When you invest your capital, never forget what should be one of your main investment goals: That your capital should be able to buy as much (and more) tomorrow as it can today.
This growth rate is also called inflation and it isn’t necessarily as high as the stars. The problem is that some people aim for the stars, fail, and after having fallen all the way down, come to the sobering realisation that getting back to their required growth rates may prove to be near-impossible.
Prevention is better than cure, and luckily there are a few ways you can curb this danger:
1. Diversification
How many times have we been told not to place all our eggs in one basket? This is, and will always be, one of the best ways to protect your investment portfolio against massive drops, especially when you are diversified across different asset classes.
Let’s take an investment in shares (JSE) over the past 10 years as example. If you had invested R100 in the JSE on 17 February 2006, your investment would have been worth R342.82 today (243% growth).
If you take a closer look at this investment, however, you will see that although you outperformed inflation quite comfortably, you would have experienced a nerve-wracking period after the first two years, followed by strong negative movements at times.
Over this 10-year period, this investment showed an annual volatility of more than 15%, which means that as an investor, you either had the chance to grow your investment by 15%, or to lose 15% of your capital.
Over the same period, the FTSE/JSE All Share Index also experienced a maximum monthly decline of more than 40% in one month.
Had you invested your capital according to a more moderate risk profile such as the South African Multi-Asset High Equity Fund, your R100 would have been worth R258.54 in this more diversified investment over the same period (159% growth).
I agree, it may not be as rewarding as an investment in shares, but at an annual volatility of only 7.2% and a maximum monthly decline of 17% during this period, you as an investor could have enjoyed 65% of the stock market’s returns at 45% of the risk.
2. Patience
As I mentioned, volatility is a given in any market, but investors only suffer losses if they start to sell.
If you decide to invest in a diversified portfolio, you should do your homework prior to investing in order to determine which investments will provide you with better returns at the lowest risk over time.
If you experience volatility over the short term, just be patient – maximum returns come with time.
3. Use the correct platform
A great platform to manage a diversified investment portfolio is by means of a linked product.
This is a single platform where you are issued with a single account. In this account, you can invest your capital in various investments, which are spread over different asset classes.
A great advantage of this type of investment is that you don’t have to withdraw any of your funds if you decide to switch to another type of investment; you only exchange one investment for another.
There are costs involved in this type of investment, however, and this should be taken into account when considering a linked product as your choice of investment.
My message this week is simple: Do not try to fly too high. Be sure to set high investment goals for yourself, but not unreasonable goals. It’s not worth your while to sacrifice a good night’s sleep because you have aimed too high with your investments.
*Schalk Louw is a portfolio manager at PSG Wealth.
This article originally appeared in the 10 March 2016 edition of finweek. Buy and download the magazine here.