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Seven lessons to guide your investment plan

Mar 31 2016 15:39
Lameez Omarjee

Investors are often bombarded with short-term data that may impact their decision-making negatively. Instead, suggests Graham Tucker, manager of the Old Mutual Balanced Fund, they should take a long-term approach to investing, filtering out the noise to make decisions that result in real returns.

Using data on asset class performance collected over 86 years, Tucker shared seven lessons all investors should take into consideration.

1. Inflation is your enemy

People don’t think about inflation as much as they should, says Tucker. Inflation erodes the real value of money and reduces spending power. Given inflation of 6%, R10 000 today will be worth R5 584 after 10 years, reducing spending power by 44%. After 20 years, this value will be driven down to R3 118, reducing spending power to 32%, he explains.

Inflation has a real impact in the long term. If your retirement income does not grow in line with inflation, you can either experience a decline in your standard of living or you will run out of money. The aim of investing should be to deliver real value (return adjusted for inflation).

2. Cash is trash

A mistake many people make is that they keep too much cash. Leaving money as cash for too long will not yield real return. Although holding cash has minimal exposure to risk, this feeling of security comes at a price of low returns, explains Tucker. He says cash should rather be deployed to other investments. However, it is hard for investors to deploy cash in asset classes that appear to be falling.

Cash does not increase your real wealth over time. Over 91 years, cash yields a real return of 0.8% a year. It will take cash 92 years to double in value, compared to 44 years for SA bonds and nine years for SA equities, according to research by Old Mutual.

3. You need equities

Equities pay off in the long term. Higher returns come at a higher risk, so investors should expect to see more volatility in the short term. But that volatility narrows out over the long term, says Tucker.

Nominal performance over 86 years shows that equities yield 14.2% a year, this is followed by bonds at 7.7% and cash yields at 6.9%. This shows that equities deliver the real return you need to grow wealth, says Tucker.

Bonds and cash may be safer options, but they don’t yield high returns. This is important for investors to consider when building wealth for retirement.

4. Time is your friend

Trading on a daily basis is a risky endeavour, with a 44% probability of losing money. When investors expand their holding period, beyond three years, the probability of losing money diminishes and is non-existent for a period of five years and 10 years into the future, says Tucker.

“As you expand the holding period, you remove the daily noise. You can earn greater returns with equities, but you need time for the risk premium to work.”

The best way to manage the risk of losing money is to remain invested in equities for longer.

5. Compounding is a powerful wealth generator

In the case of cash, investors need time in order to benefit from the full potential of compounding growth.

Investors should start saving as soon as they can to realise the benefits of compounding. You make money on your original investment as well as the gains made in previous years.

If you invest R1 000 today in SA equities, at a nominal average return of 14.3%, in 10 years, the value would increase to R3 819. In 20 years this value will have reached R14 587. 

6. Diversification

After time, diversification is the second-most valuable tool you can use to manage risk. It can reduce the impact of a single poorly performing asset in your overall portfolio.

Asset classes are volatile and in any year, any asset class can outperform the rest. Data reveals that since 1930, for 40 years (48% of the time), equities have been the best-performing asset classes. Cash was the best performer for 11 of those years (13% of the time) and listed property was the best performer for nine of those years (10%). This clearly shows it is beneficial to invest across different asset classes.

7. Asset allocation adds value

Investors should take active decisions about their asset allocations and have the ability and agility to move between asset classes. This is important to shift assets in portfolios when opportunities arise. SA bonds gave negative real returns for 40 years before delivering great returns over 30 years. Listed property went nowhere for 15 years before becoming best-performing asset class for the next 20 years. 

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