Retired reader’s question about capital

I answer a retired reader’s question about capital

The question

eggs 600x400I retired at 60 with a 20 year investment horizon, now 12 years later should my horizon be eight years, or still 20 years? Obviously at some stage I could start drawing on capital (or need to).

From “Baffled Pensioner”

My Answer

This is an issue that affects many retirees and can often be a source of real distress as they see their capital dwindling. When you determine your investment horizon for retirement, you need to take into account a few different variables. Firstly, I don’t believe you can retire at age 60 and only plan for 20 years of post-retirement life. We have a substantial number of clients who are already in their 80s and a few who are already in their 90s.

We currently plan for the person to live until age 100 when we do our retirement plan for individuals.

This might seem excessive but our clients who are already in their 90s prove the point that people are living longer and you cannot simply rely on the actuarial tables which indicate an average mortality age of 78. It is well known that middle and upper income people are living longer due to the benefits of modern medicine.

Health and longevity

If you are already 72 years old, you need to take a realistic view of your health issues and your family history. This might seem like a very morbid point, but it is still important. For instance, if your parents and grandparents lived to a ripe old age and you are in good health at age 72, it is highly likely that you might still live for many years. This means you certainly cannot plan for only another eight years, unless your health is very poor. Sorry, I know this is morbid.

Drawing on your capital

When you are retired and you find that the income your capital generates is not sufficient to meet your needs, it can be very frightening to start drawing on your capital too. This does not mean that you are necessarily in dire straits; well diversified investment portfolios can sustain some capital withdrawals over the long term.

As an example, if you have R3m invested, which provides you with your retirement income, you can draw a maximum of R240 000 per year. This amounts to 8% of the R3m. This level of withdrawal should ensure that your capital lasts for a substantial period of time, i.e. potentially 20 years or longer until it is exhausted. If you are drawing 4%, your capital might last indefinitely. A withdrawal rate of 12% is very high and you will definitely erode your capital quite rapidly. In fact, I think you will be fortunate if it lasts 15 years.

You need to be appropriately invested

If you are drawing a high income percentage from your capital, i.e. more than 8%, you cannot really afford to take significant investment risk. This means you need to invest in a cautious or moderate portfolio rather than a balanced or high equity investment. This might seem counter-intuitive. But a higher growth portfolio carries more risk and you cannot afford to lose money during a stock market crash, because you will accelerate the erosion of your capital. Ideally your investment should have a maximum of 35% to 40% in shares so that you can still get some inflation protection.

If you are only drawing 5% from your capital on a yearly basis, you can invest in a balanced or high equity portfolio. This means you can have up to 70% in shares. In good years you will get significant capital growth, which will compensate you for the bad years where you might experience a significant loss. Because you are only drawing 5% of your capital, it is likely that your money will still be able to recover after a market crash, even if it takes a year or three.

If you are drawing more than 12% of your capital every year, you should rather invest only in high interest income funds or RSA Retail Bonds, because you cannot afford any stock market losses. You need as much guaranteed income as possible. You should also try to limit your monthly costs as much as possible and find alternative sources of income or capital. For example, if you still own your home, you should consider selling it and renting a small apartment instead. This will free up some capital and limit your monthly expenses as you will no longer have to maintain your home.

Woodstock for capitalists

Warren Buffet’s Woodstock for capitalists

Woodstock for capitalistsWoodstock for capitalists is what Warren Buffett calls the annual chat he and partner Charlie Munger have with Berkshire Hathaway shareholders. It’s astounding to think 35 000 people went to Omaha in the US recently to listen to 82-year-old Buffett and 89-year-old Munger. More so when you consider these two guys have been partners for 54 years in the fifth biggest company in the world: Berkshire Hathaway, which is purely an investment company. The pair answered questions for six hours, ranging from the state of the world economy, to investment strategies, to advice for business success.

It’s impossible to sum up a six-hour Woodstock for capitalists session in a few pages. Instead I’ll try to highlight a few of their main points to show the logic of these two investment icons. To present this summary in a sensible way, I’ve divided the discussion into themes and looked at selected key points under each. Note that this is in no way a complete summary, and I have put it together by combining several sources.

What went down at Woodstock for capitalists

State of the US economy

The US economy has been in a worse position than it is today, for example, following WWII, after which it recovered well and grew for decades. “We’ve encountered far worse problems than we face now,” says the pair. “This is not our toughest hour.

If the US economy manages to increase its rate of growth, most of the current problems will solve themselves. Buffett says the problem will then fade into “insignificance”.

Greece and the EU

Buffett is critical of the decision to include Greece in the European Union. “It’s like putting rat poison into whipped cream,” he says. “Greece is not a responsible country.” But he says while it will take a bit longer, Europe will eventually solve its economic problems.

Decisions on the basis of macro-economic considerations

In the 50-plus years they’ve worked together, Buffett and Munger say they have never taken a decision on the basis of what is going on in the economy, or what the economic forecasts are. If you say you know what’s going to happen, then you haven’t don’t your homework, you’re simply uninformed and haven’t done enough research. At Woodstock for capitalists they explained: “If you’re not confused, you don’t understand things very well.”

Investment decisions

If you’re not in control of your emotions, you shouldn’t be managing your own investments. Investment decisions must be made on rational grounds, not from a behavioural or emotional departure point.

“We’ve always tried to stay sane when other people – a lot of them – go crazy. That’s a competitive advantage. When people get scared it’s very hard to deal with them. People get fearful en masse. When we see falling prices we see opportunity.” They also emphasise: “You can’t afford to go with the crowd on investing.”

When it comes to forecasts, their opinion is clear: “You can’t make a lot of money trying to think what is going to happen tomorrow.”

If you’re not a professional investor…

Ensure you are in a diversified portfolio. The best thing to do is to use low cost index funds. The investment industry is good at shifting capital from the investor to the fund manager. The best way to overcome that is in an index fund. The basis for this is that costs are lower and few fund managers actually manage to beat the index.

Interest-bearing investments versus shares

Buffet refers specifically to the US. but many of the principles can be applied to South Africa. He feels sorry for people who invest in interest-bearing investments. “For 90% of my life it has been better owning equities,” he explains. This means exposure to growth assets is critical for long-term growth.

Advice for successful business management

Here Buffet focuses on three points:

  • Manage cost and keep it low
  • Build your brand
  • Make sure your clients are happy

When asked a critical question about their investment in the motorcycle group Harley-Davidson, Buffet comes back to focus on branding: “Any company that gets customers to tattoo ads on their chests can’t be all that bad.”

The long-term nature of investing

Charlie Munger supports Warren Buffett when they explain long-term investment isn’t three or five years. It’s longer than that. Noteworthy is that a person aged 89 isn’t worried about what’s going to happen in the next three to five years.

On children, wills and inheritances

The pair recommend you share your will with your children when they are in their 30s. Buffett emphasises the behaviour of parents determines their children’s future It’s about them knowing about their inheritance, not the amount of the inheritance. The way parents work with money determines how their children will work with money.

Making an investment

Whether you only buy 100 shares in a business or the whole business, you must regard any investment as if you are buying the whole company. Buffet adds you must be prepared to pay a premium price for a quality business. “Paying up for an extraordinary company is not a mistake,” he emphasises. Buffet and Munger also believe in allowing businesses to manage themselves. “We’re decentralised almost to the point of abdication,” they said at Woodstock for capitalists.

Life advice

  • To young people the pair says: “Start developing your track record as early as you can, one that is a product of sound thinking.”
  • On career choice: “You have got to work where you’re tuned in. I have never been successful at something I did not like.”
  • Munger says: “The game of life is the game of everlasting learning.”
  • When it comes to expertise, they advise: “Knowing the edge of your competency is very important. If you think you know more than you do, that’s looking for trouble.”

Practicalities: What does all this mean for investors?

I believe Warren Buffet’s Woodstock for capitalists is a tune serious investors can listen to:

  1. Ensure you are not emotional when it comes to investment decisions. It’s better to consult a good financial advisor, who isn’t emotionally attached to your specific circumstances. One who will give you rational advice.
  2. Use cheap index fund solutions if you are not a professional investment manager.
  3. Don’t pay too much attention to macro-economic factors. Don’t rely on your ability to predict the future. The first step towards financial fitness is an executable, realistic plan that you can stick to. A plan like that helps you focus in uncertain times. It reminds you why you made certain decisions in the first place, if you doubt yourself. That’s why it’s preferable to enlist the help of an expert personal financial planner. It helps you focus on what you understand and make a success of it.

Get advice

Will you have enough money when you retire? Thinking of investing? Wondering how to repay your debt? Where to invest your money?

With a dizzying array of asset classes, asset types and more information than anyone can possibly process alone, why not speak to one of our expert financial planners? Get advice that’s tailored to your unique financial situation now.

Winning the lotto means responsibility

Winning the lotto

Winning the lotto comes with responsibility

Over the last few weeks there have been many people winning the lotto. A lot of them won big. Two lucky people shared a jackpot of nearly R60m. I have met a few lotto winners over the years and most of them have sad stories to tell about their “good fortune”.

In the USA, nearly 70% of the people winning the lotto are broke within seven years. I expect South Africans winning the lotto have the same experience. Sadly, there are real risks involved in winning the lotto. Suicides, murders, drug addiction and divorces are common themes in the stories of these previously ordinary people whose lives were ruined by a big jackpot. My first piece of advice to a big winner is: DON’T TELL PEOPLE.

Take things slowly

Take two or three months after winning the lotto to think about what you are going to do before you do anything with your winnings. If possible speak to people who are wealthy and find out how they live their lives. You can learn a lot from other people’s experiences. Don’t repeat their mistakes. Get used to the idea of being wealthy and try to plan your life ahead before you start splurging. Don’t quit your job immediately, as this is a sure sign to all your friends and family that your life has changed. If you really hate your job or your boss, try to develop a plan for what you are going to do with your time before telling the boss where to stick it. It will seem strange to most. But the combination of real wealth and boredom is very dangerous. Remember, there is no rush to do anything with your money. It’s not going to disappear if you take a few months to start making investment decisions.

Stick to things you know

The fact that you have been lucky enough after winning the lotto does not mean you have suddenly become an expert investor or business owner. When you have large sums to invest, it will not take long for people to offer you opportunities to buy into private businesses, buildings or property developments. These are the situations where you should exercise extreme caution. If you are interested in becoming an entrepreneur, make use of experts who are paid to recommend you properly, rather than commission earning agents who want to sell you something. More importantly, take all the time necessary to arm yourself with information so that you can protect yourself from bad investment decisions after winning the lotto.

Your action plan

I realise that after winning the lotto, it will be impossible to convince you not to spend some of it. Give yourself a spending budget For example, if you won R50m, you could allocate R10m to discretionary spending. Here are some sensible examples of how to spend this money:

  • Pay off all debt, including home loans
  • Pay off debts for children or parents. If you want to share your good fortune with them
  • Buy another home, if desired
  • Buy assets that have a long history of appreciating in value

After winning the lotto, try not to:

  • Spend millions on expensive cars. These will cost a fortune to insure and will lose value rapidly
  • Donate lump sums to family and friends. Rather give them a source of monthly income that continues for the rest of their lives. History has repeatedly shown that very few people can handle the swift transition from relative poverty to instant wealth.

Create a cash safety net

Set up an emergency fund that equates to six months’ of expenses. This should be used to cover unforeseen expenses only.

Create an income generating income base

If you want to make sure you can live off your remaining capital for the rest of your life, you will need to invest it so that you can earn a sustainable income from your capital. This income will need to increase with inflation. You must be careful about how much you spend, relative to the value of your remaining assets. Try to draw a maximum of 4% per year from your capital (e.g. 4% of R40m), as an annual income. If your capital is invested in a diversified portfolio of shares, bonds and property, it should continue to grow by more than inflation even after the effect of your income withdrawals. You should invest a minimum of 60% of your capital in productive assets, such as shares and commercial or listed property.

An annual income of 4% of R40m equates to R133 333 per month. From this money you will need to pay income tax and give to any friends, family and charities. Don’t plan to spend it all on yourself. Try to draw a smaller percentage in the beginning. This gradually gets you used to your new lifestyle.

Get an estate plan

There are many examples of people winning the lotto being knocked off by family members who wanted their share of the pie. This may sound like the plot of a bad movie but this has happened on many occasions in the past. In order to prevent this temptation, make sure you have a proper will that specifies where the money will go on your death. I would also seriously consider starting a trust. If on your death, your assets are left to a trust managed by independent trustees, there is little point in crazy relatives ending your life prematurely… There will also be little chance for them to squabble over your money, such as the greedy grandchildren of a certain famous man we all love.

If you feel the burden of managing this money is too much to deal with, you can consider placing the money in a trust immediately. Then appoint professional independent trustees to look after your interests for you. This is an option used by many very wealthy people around the world. Just make sure you have the right mix of trustees, who are paid in the right way. As an example, I prefer one accountant, one lawyer and one independent investment expert. More importantly, all of them are paid a fixed monthly fee and they cannot earn any money directly or indirectly from the capital of the trust. This tends to keep everyone honest and focussed on their jobs.

Summary

I believe it is nearly impossible for people to adapt to becoming instantly wealthy after winning the lotto. Especially those who have not had much experience with wealth. Those who are best able to cope are usually not motivated by material wealth. I think our lotto must follow the American example. Winners are not given all the money at once. They are paid an annual amount for a long period. For example, if you win a R50m lotto, you are paid R1m per year for 50 years. This gives you time to get used to the idea of being wealthy and limits your ability to make catastrophic mistakes with all your wealth.

Get advice

Will you have enough money when you retire? Thinking of investing? Wondering how to repay your debt? Where to invest your money?
With a dizzying array of asset classes, asset types and more information than anyone can possibly process alone, why not speak to one of our expert financial planners? Get advice that’s tailored to your unique financial situation now.

10 Tips for financial planners

Tips for financial planners

Tips for financial plannersHere are 10 tips for financial planners. Starting your career as a financial planner is an opportunity to create a life for yourself that few other people will be able to match. After nearly two decades as a financial planner – including eight years as a co-owner of a planning business, I am sure financial planning is one of the best careers for those who care as much about quality of life as they do about money.

My elderly industry colleagues regularly remind me that financial planning is the best job in the world. If we do our work correctly, we materially improve peoples’ lives in a way that few other professions can. We are able to set up long-term relationships with people that changes lives. These tips for financial planners will help you as much as they’ve helped me.

To me, you should focus on these tips for financial planners that will guide you over your entire career.

1. Build Life-long Relationships 
Try to become a trusted advisor to your clients and make sure this relationship lasts for life. With a long-term focus on relationships, you will not be tempted by short-term objectives that could compromise your advice. I always tell our new advisors to be the client’s personal financial director. Some of my longstanding clients will call me to ask my advice on what motor vehicles to buy. I have no value to add in this decision but they value my opinion and they know that vehicles are a big expense and so must be accounted for by their financial planner. I don’t mind these queries because it is another opportunity to talk to my clients and always leads to improved goodwill.

2. Put Your Clients First
In everything you do, try to put the client first, above your own financial considerations and if necessary before your employer’s priorities. This is especially true if your internal “integrity radar” is alerting you to a potential problem. You might change employers on many occasions over your career but you always take your reputation with you, if you compromise your integrity, you will become the ultimate loser, not your employer. You can only lose your reputation once, it will never recover and you will need to find a new career, probably as a used car salesman.

3. Pursue Success, Not Money
Financial planning is not about the money! This is not the career to get-rich-quickly. If that is your aim, please find another career, preferably outside of financial services. There are great financial planners who have accumulated significant personal wealth but this is a by-product of their success in their careers. If you research the world’s most successful business leaders e.g. Bill Gates, Steve Jobs, Warren Buffett and Richard Branson, you will see that they did not start out to get rich. All of them had a bigger goal, their wealth was a consequence of their success in their chosen fields. If your primary aim is to get rich, you will be tempted to take shortcuts at the wrong time. This is usually how problems start.

Good financial planners are not product sellers, products are simply tools for implementing good advice. There is nothing wrong with being a product seller unless you try to disguise product selling as financial planning. You should always focus on providing the right advice for the client, even if it means that you do not earn money from selling a product. Over time, your good advice will lead to personal financial success.

4. Don’t Make Predictions
Financial planning is not about predicting what is going to happen in markets. If you deal with money, clients often expect you to be able to tell them where stock markets are going in the next few months, what interest rates will do and what is going to happen in the currency markets. You will be tempted to appear knowledgeable so you might give them a prediction based on some research you recently read. Statistically, your prediction is likely to be wrong and this is going to damage your credibility with your client. I often appear on financial shows on TV and radio which leads people to think I have a special insight into financial matters. I am normally asked what is going to happen to our currency or stock market in the next few months and people are always surprised when I answer, “I have no idea”. Predictions about markets always make for interesting conversation but they will inevitably be wrong. Being constantly wrong is not a great way to build your professional reputation. Rather be honest and tell people that you have no idea what is going to happen and neither does anyone else.

5. Specialise in a Financial Planning Area 
The fifth in our list of tips for financial planners deals with specialisation in a specific aspect of financial planning. You can choose to be a generalist – even this is a form of speciality as there are very few competent generalists. My preference is to specialise in one area and become deeply knowledgeable about that aspect of financial planning. I chose investments for high net worth individuals as my area of expertise and I always focus on this area. If a client requires estate planning or insurance advice, I am happy to refer them to another specialist.

6. Don’t Sell Time 
Leverage yourself and don’t sell time. Professions such as lawyers and doctors tend to sell their time by the hour. There are a limited number of hours that one can work in a week which means you either have to work every hour of every working day or charge massive hourly fees if you want to earn well. I prefer to work on retainers so that I am not forced to sell hours.

7. Build Yourself a Public Profile
Write, present and educate people about money. Try to build a public profile as a knowledgable person in your chosen field. Write regular articles and get them published where possible. The internet is a great forum for getting published and you can use your social media profile to “broadcast” your articles. Try to get on the radio and TV as often as possible and always make yourself available to the media. Journalists are not good at forward planning so they will usually contact you at VERY short notice for an interview. Don’t complain, rather make it as easy for them to call on you as often as possible. You will quickly become their default contact which will guarantee you exposure.

8. Build Your Interpersonal Skills
Work on your interpersonal skills, especially client coaching skills. Technical knowledge is important but it is only the first step, there are many technically knowledgable people in our industry but very few of them can impart this knowledge to financially unsophisticated people in the proper manner. They usually resort to jargon which either intimidates clients or confuses them.

9. Always Be Available
Always be available to your clients when they look for you, especially if you have to give them bad news. Investment advisors tend to hide from their clients when markets are falling which is a cardinal sin. Always return calls and emails within one working day. This builds trust with clients and reminds them that you are there for them and will look after them, no matter what is happening.

10. Choose Clients that You Can Relate to
The last in our list of tips for financial planners is to choose clients who you can relate to on a personal level. If a potential client makes you uncomfortable at the start, pass that client to someone else. I have always regretted taking on clients who I did not “gel” with at our initial meetings. When stock markets or other circumstances work against you, it is important that you have a good relationship with your clients so you can work through the bad times. If you make an outright error, it is often possible to recover from this by being honest in your communication with your client. Some of my best client relationships were built on my recovery from a mistake. My clients always knew that I was acting with integrity and the mistakes were honest ones. More importantly I alerted them to the error as quickly as possible and I ensured that I rectified my mistake quickly.

In summary, use these tips for financial planners. If you protect your integrity at all costs, focus on your clients and their goals and develop a long-term game plan for your career, you can build a wonderful and constructive life for yourself, your family and your clients.

Get advice

Will you have enough money when you retire? Thinking of investing? Wondering how to repay your debt? Where to invest your money?

With a dizzying array of asset classes, asset types and more information than anyone can possibly process alone, why not speak to one of our expert financial planners? Get advice that’s tailored to your unique financial situation now.

Uncertainty and volatility must not scare you

Uncertainty and volatility can seem scary… don’t let this worry you

Uncertainty and volatility can seem scaryThe devaluation of the rand. Labour disputes in the mining and agricultural sectors. Concerns about our economic future. These issues all unsettle investors. The fact that the stock market performed well in 2012 is amplifying the fear. Investors worry the market cannot continue going up for longer. Should you be worrying about uncertainty and volatility too? What should really worry you; uncertainty, volatility or inflation?

Volatility is not risk

I always get grumpy when I read marketing material from fund managers. They brag about the low volatility of their funds as if this means their funds are somehow less risky than their competitors’. It’s hogwash to equate uncertainty and volatility to risk. Especially if you are a private person who needs to make smart, long-term investment decisions. If you want to generate real capital growth, pray for uncertainty and volatility. Investments with no uncertainty and volatility are either very low risk and stand little chance of beating inflation, or these are Ponzi schemes.

Uncertainty and volatility give opportunity

Where would you rather invest your money today, in platinum miners or the listed property sector? I’m sure many people prefer listed property. The returns have been great (especially last year). There is a good chance these companies will generate income and profit in the next few years.

What about platinum? The unions seem hell-bent on destroying their source of employment in a lethal game of chicken to get higher wages for a reducing number of employees. Some platinum miners are even being publicly targeted by Government. This is never a good sign for investors. However, if forced to allocate money to only one specific sector today, I would consider platinum miners and not listed property. There is good value in these miners. They have no international competition, so they have a natural monopoly. The uncertainty and volatility facing the sector is precisely what creates the investment opportunity.

Manage uncertainty and volatility, don’t avoid it

Most international markets, including SA, have performed well recently. Uncertainty and volatility has reduced and most equity investors are in a comfort zone. This is probably a good time to start worrying. Complacency coupled with equity investment is never healthy. The chance that equity markets will generate reduced performance in the years ahead is increasing. It will be difficult for most asset classes to beat inflation over the next three to five years.

Am I saying you should sell out of equities? Definitely not. I do recommend you diversify your portfolio across a range of sectors and asset classes. No-one knows if the stock markets will continue to run for the next year or three. I prefer earning dividends and not interest on cash. Optimally diversify your assets  in volatile conditions as an effective strategy.

The best investors never invest with absolute conviction. They realise the stock market will always do the unexpected in the short-term. This means they don’t bet the house on one particular strategy. Smart investors allocate some capital to one strategy. But if they’re wrong, they will have capital allocated to other strategies too. They do not take unsustainable losses. Absolute conviction with investment is always fatal to capital growth.

Inflation is your real risk

Over long periods of time the effect of inflation on your money is your real concern. If you don’t invest in productive assets such as shares and commercial property, you are guaranteeing the value destruction of your capital. This is especially true if you invest in cash and other “low risk” assets, because you want to avoid uncertainty and volatility. This is not a good strategy for long-term investing.

Productive assets are by their very nature volatile. Ideally you should focus on the income from these assets. If the income they generate increases faster than the inflation rate, the volatile nature of the capital invested is not relevant. It’s one of the reasons why Warren Buffett avoids IT companies. He cannot predict their income in the next 10 years. Therefore he allocates his capital elsewhere.

If the markets take a beating in the next year or two, I will probably increase my allocation to shares beyond my normal targeted percentage. But I will always maintain some asset class diversification. Just in case.

Get advice

Will you have enough money when you retire? Thinking of investing? Wondering how to repay your debt? Where to invest your money?

With a dizzying array of asset classes, asset types and more information than anyone can possibly process alone, why not speak to one of our expert financial planners? Get advice that’s tailored to your unique financial situation now.

 

Optimists win

Will it surprise you to know wealthy people are generally happy optimists? Probably not. In fact, most of us probably believe affluent people are happier because they are wealthy. But most of us will be wrong. Those who have achieved a measure of success in their lives have generally been optimistic and happy over their entire lives. This is also true for achievers in the fields of business, investing and sport. Those of us who live at the tip of Africa in a turbulent country can learn from these achievers.

Happy people make more money

Happy peopleA recent blog post on The Wall Street Journal site (It pays to be happy, 4 January 2013) quotes new research that finds people who are consistently happy with their lives typically earn more than unhappy people. Happy people earn an average of R32 000 per year more than the average. More worryingly, those who are “profoundly unhappy” earn 30% less than the average. It proves the point that there is a link between wealth and happiness. But it seems the path to wealth starts by being happy. Unhappy people are less likely to prosper in their careers and therefore are also less likely to be wealthy. It’s interesting that people who are generally happy from the age of 18 to 22 tend to be more successful later in life.

Optimists

After years of advising wealthy individuals, I have always been surprised by how much more positive my wealthier clients are than those who are of average or below-average wealth. I used to attribute their positive outlook to the fact that they had money to solve any potential problems. But as I found out more about these clients, I realised I was wrong. When I started to ask my clients about their early lives and in particular how they responded to setbacks, I was always surprised by how positive they were – even from an early age. They tend to have a natural belief in their ability and feel if they apply themselves positive results will follow. This is particularly true for entrepreneurs who started their own businesses.

When you ask these entrepreneurs what made them successful, many of them attribute their success to their perseverance. It’s highly unlikely a natural pessimist would persevere in a tough business, when things are going badly, whereas optimists would. It’s no coincidence most CEOs of large listed companies are optimistic by nature. Many of them are accused of being cheerleaders who always focus on the positive, without much regard for the problems facing their companies. To some extent this is a valid criticism, but one needs to understand these CEOs do not view problems in the same light as pessimists.

Investing: Try being an optimistic realist

In my experience successful investors (meaning people who have done well over decades), are almost universally optimists at heart. However, they are not unrealistic or irrational in their expectations. When I meet new people and we discuss investments, I try to get an understanding of the person’s outlook on life.

Natural pessimists are often calm in the midst of an economic meltdown because they were expecting it. However, when the market is doing well, they are usually concerned about the next crash. This might seem like a sensible attitude to money (it is), but pessimists usually have limited wealth in their later years.

The cause is simple. As they have always been “sure” the markets will crash they have tended to under-invest over their lifetimes. This decision has inevitably cost them many opportunities.

Personally it’s my 2013 goal to approach investing and business with a realistic, but optimistic view.

Get advice

Will you have enough money when you retire? Thinking of investing? Wondering how to repay your debt? Where to invest your money?

With a dizzying array of asset classes, asset types and more information than anyone can possibly process alone, why not speak to one of our expert financial planners? Get advice that’s tailored to your unique financial situation now.

 

Investment advice for 2013

How to manage your investments and why predictions are a waste of time…

2013 200x300Every year I get asked to make a range of predictions including: what will the rand do, how will the JSE perform, will the residential property market recover and what will happen to the overseas markets?

Without fail, I try to explain that any prediction – irrespective of who makes it – is largely worthless. After I have explained why, some people look at me with a quizzical expression and promptly ask me to ‘guess anyway.’ If we look at what happened in 2012 as an example – hopefully we can see why investment predictions are a waste of time.

Best performing assets in 2012

According to the Economist magazine, the best performing asset class in the world in 2012 was Greek government bonds. These returned more than 80% for the year. Portuguese government bonds were a close second. I cannot recall many investment gurus predicting this. More to the point, you would be hard-pressed to find many globally diversified unit trusts that had a sizable allocation to either of these asset classes.

I am not critical of the fund managers who did not allocate 20% of their portfolios to Greek and Portuguese bonds; it would have seemed reckless at the time. However I believe it proves the point that you cannot formulate a proper investment strategy based on predictions. You will either be horribly wrong or miss out on the spectacular performers.

In terms of stock markets, it has been widely reported that the Venezuelan Stock Market rose by more than 300% for 2012 (not sure why the Economist missed this) whilst Turkey and Nigeria’s markets returned nearly 60%. Even Greece’s stock market outperformed South Africa’s with a return of 32%. I am sure that none of these sectors would have been on your Top 5 Best Ideas list for 2012.

How to manage your shares in 2013?

At current levels, the PE ratio of the JSE is 15 which means it is now slightly above long-term average value. The market is not very expensive yet, we have seen PE’s of 20 in the past. There are still pockets of value – resources and construction in particular – but one needs to be cautious about some of the other sectors including property, retail, industrials and financials.

I think valuations should play a crucial role in any new investment decisions for 2013 – even more than they normally do. If you have new capital to invest in the JSE, you should seriously consider phasing your money into the market over the next few months.

If you are a stock picker, aim for sectors of the market that are trading at or below their long-term average PE’s. The retail sector is near its highest valuations and cannot offer great value to investors at this stage. However if I were a long-term investor with exposure to retail shares, I would not sell all my shares at this time. I would rather be reducing my exposure so that retail forms a smaller part of my portfolio – below your long-term ideal allocation.

It is important to ensure that you are not absolute in your investment decisions. So, if the retail sector continues to boom for the next three years, you should still be able derive some benefit from the boom. However if it collapses in June you will still be in a good position if you have already taken some good profits in January and allocated them elsewhere.

Try to remember that more than 50% of your total equity return comes from re-investing your dividends over time. If you are out of the stock market completely, you are not earning dividends therefore you are limiting your potential returns in the long-term.

It is also important to watch the profits (earnings) and especially the dividends paid by the larger listed companies. If profits and dividends increase more than their share prices increase, the valuation of these companies will decline. This is obviously an ideal scenario and I am not convinced that this will unfold (especially for the retail sector) but it is not impossible.

To index investors

This is one of those times in the market when active stock pickers will be arguing that you are crazy to invest in the index when it is breaching all time highs on a regular basis. As an index fan, I think this argument has limited merit. There are great indexed investments that are still worth consideration. Personally, I like the ETF’s that limit your exposure to sector bubbles. For example equally weighted ETF’s and fundamental indices are worth consideration, especially if you phase your purchase into the index over time.

At all times, make sure that you focus on the cost of your investment, the lowest cost investments inevitably provide the best growth over longer periods of time. This is particularly true of ETF’s.

I am not normally a fan of offshore equity investments because I think your returns (when adjusted back to rand values) are muted. However the valuations of international markets are still low and do provide some diversification benefit to SA investors, especially if our market reaches PE’s of 18 to 20.

Although I am a massive fan of the listed property sector, I am very concerned about valuations. I would be very cautious with this sector.

In summary, try to maintain a balanced investment portfolio through this year. If you have firm views on the direction of the market, try to ensure that some of your investments will still do well even if you are wrong. This means having a diversified portfolio of shares and other asset classes.

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Three steps to financial freedom

I was recently asked by a student why it is so important to spend so much time and energy on savings and investments when it seems like investors get no reward for their efforts. The point was made that people derive pleasure from spending on holidays, clothes, cars and entertainment, so why invest? This is a great question that most of us deal with every day in our own lives when we decide whether to buy, spend or save. Without a clear goal to inspire us, most people will spend – not save.

What is financial freedom?

The final step towards financial freedom is when the income from your assets exceeds your expenses. Financial freedom is quite different from being wealthy because some people have financial freedom with an asset value of R5m whilst others who have assets of R50m are not financially free. It is not possible for everyone to become truly wealthy (despite the Hollywood fairy tales) but anyone can be financially free. I have met many people who have retired with relatively small amounts (under R5m in investments plus a paid off home) who are living fantastic lives as retirees. The real secret to their success is that they have accumulated sufficient capital to cover their expenses and they have controlled their expenses.

There are various degrees of financial freedom – I think the first step towards financial freedom is when you are debt free. Most people struggle to get past this step because they constantly increase their debt burden as their income increases. The average high income earner in South Africa is three months away from financial difficulty in the event of a loss of income because of this behaviour. They buy more expensive vehicles and houses because they can afford the higher monthly payments but they never pay off their debt until it is too late. If you can break this debt cycle by limiting your debt and paying it off more quickly as your income increases; you are already 80% of the way to financial freedom.

The second step in financial freedom is to build an asset base. The first asset you need is an emergency fund that you use in the event of a financial disaster. You should aim for an amount that is equivalent to half your annual expenses and this should be saved in a fixed deposit or 30 day notice account.

The third step is when you start building your income generating assets that will eventually pay your expenses in future. This is the step that most people focus on i.e. where is the best place to put your money to get the most growth with the least risk. There is one implicit aspect that most people ignore about this step; you must continue to spend less than you earn – try to save 15% of your total annual salary. It is important to understand that your initial capital will take the longest to build because you do not have the benefit of compounding yet. As an example it will probably take about 8 years to save your first R1m but your second million will only take 5 years and your third will only take three years. This is because of the effect of compound growth and not because you are saving more. Your greatest allies in this phase are patience and discipline.

Financial freedom is possible for anybody

If you need R10,000 per month to cover your expenses you only need R2.7m of investments to be financially free for the rest of your life. This is the real key to financial freedom, try to ensure that your expenses are really low and you will be in a position where you don’t need a salary far earlier than you think. I realise that most people don’t want to live on R10,000 per month but if you get to this position, you will be able to make better decisions about your life without worrying about a salary. Most people who reach this position are able to change their lives substantially – these are some of the reasons why:

  • You have less stress because you don’t have to generate a salary every month,
  • You have the freedom to do the work you choose e.g. start a business,
  • You can do a job you like, rather than a job you hate that pays better,
  • If you have a lousy employer, you can quit.

The only way you will have the necessary patience and discipline to take the three steps to financial freedom is if you give yourself a goal to work towards. Try to identify what will motivate you to spend less every month and not to buy the biggest best car you can afford. Make this goal your mantra and every time you get the urge to spend think of your mantra, within a few years, you will be on your way.

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Make your first million

It is simple but not easy to make R1 million from investing, all you need is: R5,000 per month, some patience and discipline.

The formula

There is no easy way to get rich quick. People who have become wealthy in a short space of time have either gambled or been extremely lucky. Your only guaranteed way to get rich is to follow a few simple (but not easy) steps and be patient for a few years.

Step 1: Get out of debt

You cannot get rich if you have short term debts such as credit cards, clothing accounts and overdrafts. If you really want to become wealthy, you need to pay off these bad types of debt as quickly as possible. Thereafter you can keep your good debts such as home loan and car debt.

Step 2: Build an emergency fund

You need to build up a cash account that is accessible at short notice. Try to keep 3-6 months worth of your monthly expenses in this account. It is not an investment and should only be used to pay for emergencies such as a car breakdown or insurance claim. The purpose of this account is to avoid the situation where you have to sell investments at the wrong time.

Step 3: Start saving

Younger people can invest all their savings in shares because they have the time to let these investments grow. In your lifetime as an investor, you are going to see many stock market crashes and recoveries, your job is to simply keep saving through all of them. Ignore all the people and pundits who will try to scare you out of saving, just keep your head down and stick to the plan. Ideally you should save as much as possible in the beginning. Try to ensure that you save a minimum of R5,000 per month. I realise that R5,000 might seem like a large amount in the beginning but you have to decide – do you want to be financially independent or do you want to work for a salary for the rest of your life? As I mentioned at the start of this article, it is simple but not easy to get rich.

Step 4: Where to invest

The ideal place to start saving is in an exchange traded fund (ETF) or indexed investment. ETF’s are low cost investments that will generate fantastic growth over the long term. If you want to start making a million rand every 2 to 4 years, you will first need some capital. As they say, “Money makes money.” By now, I am sure you are wondering how on Earth you are going to make this kind of money so quickly.

How it works
  • You need to save R5,000 every month for a period of nine years.
  • Try to invest all this money in the stock market e.g. in an ETF.
  • After nine years, you will almost certainly have a R1 million worth of investments.
  • If you keep investing R5,000 and add it to the first R1 million, you should have another R1 million within 4 years.
  • By sticking to the plan, you should have your R3m in total within 16 years.

Whilst 16 years might seem like a long time, you can reduce the period by saving more money as your salary increases over time. Any bonuses or other lump sums that you can add to the investment will speed up the process significantly. There is a real-life example below of someone who has saved R750,000 in less than four years.

Why this works

It is possible to save this kind of money because of the growth potential of the share market and the power of compound growth. Since the year 1900, the stock market has generated an average return of 7% above inflation per year, which equates to a nominal return 12.5% per year. That means you don’t need to be a rocket scientist or have any special stock market knowledge to be a successful investor – you just have to be disciplined and patient.

The real-life example

In February 2007 I met a young person who asked me to advise her on how she should start investing. She was 25 years old and had R9,000 to invest every month. We worked out a plan very similar to the one outlined above and she implemented it on her own for the next 3.5 years. In June this year, she emailed me to say that she had more than R700,000 in her share portfolio (primarily ETF’s) and was hoping to have R1m by the time she was 30, she is nearly 29 now. As her career progressed, she started earning very good money at an early stage in her career but she maintained a low-cost lifestyle. She did not buy fancy cars and she continued to rent a small apartment – this was the difficult part of the plan but she did it relatively easily. Most of us would be tempted to start spending more money as our earnings increased, she avoided this trap and is now on her way to financial independence.  She is now considering the option of starting her own business in a few years because she will have enough savings to live off. That means she won’t need a job or a boss, she will be financially independent before she is 35 years old. To me, this is the best reason to save when you are young – it gives you the freedom to make great life-changing decisions.

Conclusion

I realise that most people can’t earn the same salary as the person in my example but everyone can follow her formula. As you can see, there is no secret recipe,  you just need to save constantly and keep your lifestyle costs in check.

Get advice

Will you have enough money when you retire? Thinking of investing? Wondering how to repay your debt? Where to invest your money?

With a dizzying array of asset classes, asset types and more information than anyone can possibly process alone, why not speak to one of our expert financial planners? Get advice that’s tailored to your unique financial situation now.