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A friend of mine likes to tell the story of the farmer who bought a few lambs with the intention of expanding his farming activities.
He fed the lambs well and placed them in a small pen.
He then set up his camping chair next to the pen, so he could keep a close eye on them.
After a few hours, he became frustrated, because he didn’t see any of them grow. Furious, the farmer took his chair and left, vowing never to waste his time with sheep farming again.
About a year later, upon driving past that very pen, he was surprised to see that the lambs he left there were now full-grown sheep and that they had given birth to lambs of their own.
It’s a simple example, but very relevant to investors.
With markets as volatile as they are, it’s perfectly understandable that investors are currently becoming frustrated.
And why they also want to take their camping chairs and leave.
Although we saw a positive start to the year and the FTSE/JSE All Share Index grew by 8% in the first three months, we also have to remember that this very market declined by 7% in the last half of 2018.Big market fluctuations have a tendency to affect investors’ emotions and to make things worse.
It appears as though these uncertain market conditions aren’t about to clear up just yet.
No different to the farmer who was supposed to know what he was letting himself in for, investors too should know what they are letting themselves in for when investing in different asset classes, especially when it comes to their pension funds.
I often hear investors saying that they should have an investment horizon of at least five years when it comes to investing in shares, while bonds, for example, should be safe over a two-year period.
Let me first quantify what I would consider to be ‘safe’. Historically, shares would have provided you with the best returns over a five-year period quite comfortably, but how does this asset class compare to inflation?
Remember that if your investments cannot outperform inflation, you may just as well spend all that capital right now, because you won’t be able to buy nearly as much in the future with it as you can buy with it now.
Upon closer investigation, I found that there were quite a few times over the last 30 years when shares were actually not able to outperform inflation over a five-year (rolling 60-month) period.
Investors would have been better off had they waited seven years to check on the growth of their “lambs”.
The same goes for bonds.
There were also quite a few times that bonds were not able to outperform inflation over a two-year (rolling 24-month) period and investors would have been better off with a three-year investment horizon.
If you are firmly focused on absolute returns and require an income from your portfolio at the same time, it may be advisable to consider investing your first year’s income requirements in money market as an asset class.
I would invest the following four years’ inflation-adjusted life capital in bonds, while allocating the remaining capital towards growth assets, such as shares (among others) to achieve long-term growth.
Given the current turbulent market conditions, however, I would advise consulting an expert to assist you with your asset allocation and the more accurate distribution weights of your capital towards each class.
For now, I urge investors to remain calm.
Use the negativity we have been experiencing over the last few years to restore balance to your portfolio, especially where local shares may have become underweight.
Put away your camping chair and give your investments a proper opportunity to grow.
Schalk Louw is a portfolio manager at PSG Wealth.
This article originally appeared in the 18 April edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.
