Why do we invest? This is a simple question that can be answered in many ways.
We all have our motivations for investing our money and entrusting it to the strategies, philosophies and conscience of the financial markets. The reason I invest my money is simple: I want to earn a positive yield/return on that money. I invest to earn interest, compounded interest to be specific, and in doing so hopefully double my money within what I deem a reasonable term, within acceptable risk parameters.
This is a simple request that in a low-growth investment market seems to be trying to extract water from stone.
There’s something about the idea of doubling one’s money on an investment that intrigues most investors. It’s a badge of honour, because this simple aim has no linear or fixed method for achieving it.
Some over-zealous investors have lost their money in pursuit of this badge, bamboozled and seduced by the investor psychology – the risk-taking part of us that loves the quick buck. Don’t be discouraged though. This Everest can be conquered. The summit is both a realistic goal that investors should always be moving toward, as well as something that can lure many people into impulsive investing mistakes.
I’d like to share a proven strategy that many have used, with varying success, to navigate the path of ‘doubling my money’.
The Classic – 1964 Aston Martin DB5
If it’s cool enough for Bond, it’s cool enough for us. If you had to pick one vehicle that James Bond relied on the most, you’d be hard-pressed not to go with the DB5. So, what is the DB5 of investment strategies? How do you double your money?
You earn it slowly. Slow and steady wins the race. You might find yourself falling asleep at the wheel, but it works. How do you turn R100 000 into R200 000 into R1 000 000? Decide ahead of time what the best companies in the world are, wait until they are under-valued (usually due to a market-collapse or scandal) and then allow time and compounding do the rest.
The problem with most investors is that they are impatient and expect lottery-like returns every year, which is unrealistic.
You can be cynical about it, but any rational investor will tell you that successful investing is about being smart enough to assess and valuate an asset and then being patient and passive enough to wait.
You merely have to exercise a capacity that almost no investor is willing to use, in a world where almost no one really thinks long term anymore: patience.
Suppose you were building a house. Wouldn’t it be great if you could build the foundation and have the foundation automatically build the floors, the floors spontaneously generate the walls, and the walls automatically grow the roof? Once you had laid the foundation, your only remaining job would be to do nothing…to sit and wait for the house to finish building itself. The dream of a foundation that builds a house is a perfect description of what happens when you harness the greatest wealth-building power there is…a power that Albert Einstein called, “the greatest mathematical discovery of all time”.
Einstein was talking about the power of compounding.
Perhaps the most tested way to double your money over a reasonable amount of time is to invest in a solid, non-speculative portfolio that’s diversified between blue-chip stocks (including real estate investment trusts) and investment grade bonds. While that portfolio won’t double in a year, it almost surely will eventually, thanks to the old rule of 72. The rule of 72 is a famous shortcut for calculating how long it will take for an investment to double if its growth compounds on itself. According to the rule of 72, you divide your expected annual rate of return into 72, and that tells you how many years it will take to double your money.
So, the question remains: how do you value and assess a great stock, and when do you buy and sell this stock?
An enigma, wrapped in a riddle, enclosed by a conundrum
The rise and success of passive funds have certainly cast doubt over the abilities of fund-managers to do exactly that. Assess the market, buy an asset below its intrinsic value and hold it long enough for it to generate above-market returns for your portfolio – this is not an easy thing to do and has led to fund managers being questioned about their fees and what, if any, value they provide. I find it funny then, and proof of the irrationality of the market, that large amounts of money being directed into passive strategies make the market less able to react to minor distortions or minor declines on the fundamentals side.
The more money that flows into passive strategies and the less efficient this makes the market, the more opportunities there will be for active managers to exploit those inefficiencies and generate outperformance. This is a topic that was expertly covered in a recent article by Patrick Cairns here.
Perhaps the most classic barometers used to gauge when a stock may be oversold is the price-to-earnings ratio and the book value for a company. Both measures have well-established historical norms for both the broad markets and for specific industries. When companies slip well below these historical averages for superficial or systemic reasons, smart investors will smell an opportunity to double their money.
Good fund managers, in my opinion, buy – not because everyone is getting in on a good thing but – because everyone is getting out. They buy when there is blood in the streets, even if the blood is their own. Even the biggest supporter of passive funds can agree that there are times when good investments become oversold, which presents a buying opportunity for brave investors who have done their homework. If you aren’t brave, if you aren’t willing to do the homework, then either don’t invest or stick to passive strategies.
Don’t blame fund managers and advisors for your losses. Nobody forces you to use them in the first place. If you feel the fees they charge doesn’t yield acceptable investment results, fire them. Yes, they have a fiducial responsibility to invest your money ethically and with competence, but it is still your money. Should your advisor or fund manager not do so, they will have to face the Financial Services Board and possible debarment, but you should never entrust that money to an organisation or person whom you haven’t vetted to the best of your ability and satisfaction.
Even then, you will have poor investment periods. If you can’t accept that as an investor there will come a time when you’ll lose some money or have poor performance, why are you in the market to begin with? It just makes no sense.
Guidelines for a personal strategy
Now is a particularly important time to make sure your asset allocation is matched to your time horizon. A traditional asset mix is the classic 60% equity/40% bond split, with a shift to 50%/50% by retirement. Spread your money widely. The typical investor should hold 20% to 30% of their portfolio allocation in foreign equities, including 5% in emerging markets, with the core of their offshore holding being in developed markets.
To minimise risk in your stock portfolio, consider the role of bonds and cash in your fund. These assets provide safety, not spending money. Any long-term investor will tell you that time in the markets results in years of relative calm, followed by the return of expected volatility to the stock market. Higher-quality bonds offer your best hedge against stock losses. Stick with unit trust funds and exchange traded funds that hold either investment-grade, or the highest-rated junk bonds. Don’t rely solely on government issues. Corporate bonds will give you a little more yield. Short-term bonds are sensitive to moves by the Reserve Bank to push up or decrease rates.
There’s an old saying that states that a fool and his money are soon parted. There are many scams and ponzi schemes that have been set up with the sole aim of taking advantage of your greed. I’m almost certain there are probably more investment scams out there than there are valid, licensed, regulated investments. If it sounds too good to be true, it probably is. Always be sceptical of a promise of high returns. Research any investment opportunity or advice. It is a broad suggestion and not to be taken as investment advice as defined by the FAIS Act 37 of 2002.
If we haven’t had a full consultation, then I don’t know your personal circumstances and I don’t know your financial needs. Don’t use this article as your sole investment tool. Speak to different advisers, read, empower yourself and somewhere in all that information your truth will lie.
Investing is a simple yet effective way to grow your wealth when you know what you’re doing and have the patience to test your conviction on a strategy.