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.

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What to do with the holiday home

Holiday houses rarely prove to be dream investments and often become a burden and source of frustration to their owners. With the sad state of the property market, there is little point in selling this investment so here is an idea to get some benefit from a problematic asset.

Swap it

Let’s face it, if you bought a holiday home on the SA coast in the late 1990’s or early 2000’s with the hope of making money on the booming property market, you are probably regretting your decision now. Not only is the price of your property stagnating but it is costing you real money in maintenance costs and property taxes and interest if you mortgaged the property. If the property is a lengthy distance from where you live, you are not able to enjoy the use of the property as much as you would like. If you find yourself in this unfortunate position, you should consider making use of the property to get some low cost overseas holidays for you and your family by swapping your house.

People have been swapping homes with strangers for decades. The first house swapping company was started in the 1950’s and the world’s largest home swapping business has more than 40,000  properties in 140 countries – South Africa included. You normally pay an annual subscription fee to list your property and to see other properties listed around the world. Some of the businesses offer a rating system where the property and the owners can be rated. Once you have identified a property, you will then contact the owners directly in order to negotiate a swap. This is not a quick exercise like booking a room in a hotel but sometimes you can negotiate the use of a vehicle or cleaning service and it will give you a chance to get to know the other owners a bit better.

Benefits

If you have children and would like to introduce them to some other countries around the world, you will quickly realise that hotels are very expensive when you stay in a major city like Paris, London, New York or Hong Kong. In fact, your accommodation costs will be expensive in most cities. If you arrange a house swap with someone in a major city, you might be able to swap your 3 bedroom holiday house for an apartment in the city. This will cut out a major portion of your holiday cost and make overseas travel more affordable.

One of the great benefits of doing a house swap is that you can experience a city like a local. Hotels are often situated in “downtown” locations which are more suited to business travellers. On weekends these areas become very quite and are not suited to vacationers. In addition, you pay inflated prices for everything as people try to profit from tourists at every turn. By staying in someone’s home in a residential area, you will pay normal prices which will further reduce your costs. If you like to travel overseas, especially on longer holidays, you might find that your savings make the costs of your own holiday house more palatable. In addition you can still stay in your holiday home when you choose to do so. This seems a much better proposition to me than timeshare which is expensive and restrictive.

Be careful

As with any form of “direct” holiday arrangements, you need to be prepared to do some homework in order to get the cost savings. I would suggest that you use one of the larger house swapping businesses and try to use properties that have been reviewed or rated by others. There are many different businesses offering a listing service, the links below are some examples:

www.homeexchange.com

www.houseexchange.org.uk

www.aussiehouseswap.com.au

Before embarking on this exercise, you should contact your insurers to make sure that there are no problems with doing a house swap. If you are not charging for your home, it is not considered a commercial venture which means that you should not be charged more for doing a house swap.

When selecting a potential property, make sure that the property is suited to your requirements. If you are looking for the big city experience of New York, make sure that you are not staying in an apartment which is 90 minutes commute from the places you want to see. Local commuting is not cheap and if you are relying on public transport, you do not want to spend three or four hours per day travelling. Similarly, if you are looking for a quiet beach holiday in Spain, make sure that you don’t stay in an area that is inundated with inebriated partygoers every day in their summer holidays.

Try to get a friend or neighbour to hand over keys and check in on your “tennants” whilst you are away, this should give you some piece of mind and ensure that someone keeps an eye on your place.

I am not an advocate of buying holiday houses and would certainly recommend that people sell their properties if they need the money. However, house swapping does seem like a good way to make lemonade from your lemon.

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The perfect Portfolio?

Many South Africans love physical property as an investment. Personally, this fixation has always fascinated me as I wonder if these property investors know what they are missing by ignoring the other major investment types available to them. For example, listed property companies that trade on the JSE have been fantastic investments over the last 10 years. People who bought these companies have earned 22% per year over the last 10 years and they earned this growth without having to deal with tenants or maintenance issues. This is only one of the alternative investments available to individuals who are willing to consider alternatives to residential property.

Long term history is a good indicator

The table below shows the long term returns of all the major investment asset classes available to South African investors. The returns over 10 years are most relevant as the 2 to 5 year information is too short to be helpful although it does make for interesting reading.

10 Year Return of Major SA Asset Classes

10 Year Return of Major SA Asset Classes

It is clear from the 10 year history that listed property and shares (equities) are an ideal combination for long term capital growth. If you include bonds as a stable, inflation-beating asset, I believe you can create the ideal portfolio for any individual simply by using a stock broking account. If you are reasonably young and looking to grow your assets without an immediate requirement for income, you could combine an investment in shares with listed property. A good allocation would be 75% in shares and 25% in property.

If you are looking for a combination of capital growth and income, you could reduce your allocation to shares i.e.: 50% equities, 25% bonds and 25% in property. This combination should ensure that your capital grows more than the inflation rate whilst generating a good income. If you are not built to cope with the volatility of the stock market, you could reduce your investment in shares to 35% and increase your investment in bonds to 40% and property at 25%.

The costs of creating and maintaining any of these portfolios would be quite low (initial brokerage plus a monthly portfolio fee) especially compared to buying physical property assets. If you are considering buying residential property, you will be paying massive transaction costs and ongoing maintenance costs.

In addition, your risks in a listed property investment are significantly lower as your property portfolio consists of hundreds of offices, factories and shopping centres rather than a limited number of individual properties. You will never have to go to court to evict a non-paying tenant nor will you have to worry about inefficient municipalities etc. because your assets are managed by professional managers who get paid to do this stuff for you.

What to invest in?

The easiest (and probably most cost effective) way of creating a diverisfied portfolio for yourself, would be to invest in Exchange Traded Funds (ETF’s). ABSA offer two diversified ETF’s (called MAPPS) that you can buy via your stock broking account that will give you the necessary equity and bond exposure. You can then add your property exposure via the Proptrax ETF’s or you can buy individual property shares.

Some costs are declining

When ABSA launched the MAPPS ETF’s, I was really excited about these investments until I found out how much ABSA were charging to manage them. I am very glad to see that they have recently reduced the costs of these investments substantially; so that they are now really attractive investments. Unfortunately, I feel that Proptrax are charging too much to manage their ETF’s which makes it difficult for me to recommend these investments at this stage.

Is the market too expensive and should you wait to invest?

The JSE is on a charge at the moment and is breaching new highs on a regular basis and this is causing people to question whether the market is getting too expensive. This is one of the themes that financial journalists start repeating whenever the markets do well for an extended period of time. I agree that you need to be careful when investing your capital into this market however; your decision should always be made in context. The JSE index might be above 34,000 but the PE of the market (its real value) is near 13 which is well below its historic highs. I become very fearful when the JSE gets close to a PE of 19 but not at 13! Many fund managers are suggesting that foreign markets are trading at lower PE’s than the JSE and therefore we should rather invest offshore. I think this misses the point that the JSE itself is not in expensive territory yet. If you are investing on a monthly basis, you have no cause for concern whilst lump sum investors should probably make their purchases over a number of months to reduce the impact of volatility on their investments. There is certainly no need to avoid the JSE in the hope that it will drop in the near future, the market could continue on its path for many months yet.

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.