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Investing: Focus on the fundamentals

It is important to understand what risks you are buying into when putting your hard-earned money to work.

Money is transactional in nature and, as such, can be invested to produce future wealth for us. However, investing is risky – especially in a time of global crisis – and it is important to understand what risks you are buying into when putting your hard-earned money to work. Without risk, there is no opportunity to earn the returns you need to create wealth, so what does long-term investing involve?

Beating inflation

Firstly, the primary purpose of investing is to beat inflation by investing in a range of assets including shares or equities, property, bonds and cash, or a combination of all. Inflation is a way of showing how prices change over time and relates to the purchasing power of your money. If your money only keeps pace with inflation, it will be impossible to create wealth over the long-term. Historical investment data reveals that an investor can expect before-tax investment returns of inflation +1% from cash and inflation +2% from bonds. It further reveals that investors can expect inflation +4% from property and inflation +6% from shares. While cash never produces negative returns, bonds, equities and property can and do – over the short-term. Over the long-term, equities, bonds and property have always outperformed cash.

Food for thought: ‘How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.’ (Robert G. Allen)

Longevity

If you are investing for the long term, one of your main goals will be to ensure that you do not outlive your invested capital. Longevity is a major risk facing those investing for their retirement because estimating how long you are going to live is impossible. What we do know, however, is that medical science is keeping us alive for longer – often with life-limiting medical conditions – and this comes with a hefty price tag. When investing for the long term, make sure you factor in the possibility of living to age 100 or beyond.

Food for thought: ‘Invest for the long term.’ (Lou Simpson) 

Risk

Although risk is integral to investing, it is important to understand how much risk you need to take in order to achieve the returns you require. At the same time, it is also important to understand your propensity for investment risk and how you will react to short-term market fluctuations. Further, your investment horizon will also play a role in determining how much risk you can expose your capital to. If you’ve just started investing for your retirement, you have the benefit of four – potentially five – decades – to accumulate wealth, and can, therefore, expose your money to higher-risk investments that can weather market fluctuations over the long term. Although it can be emotionally draining to deal with the volatility of stock markets, investors need to find a level of risk that they can live with while adequately dealing with the effect of inflation over the long term.

Food for thought: ‘In investing, what is comfortable is rarely profitable.’ (Robert Arnott) 

Volatility

Investment markets are by nature volatile and accepting short-term fluctuations is an investment fundamental. Markets move in cycles through peaks and troughs and, as an investor, you need to be emotionally prepared to confront this reality without becoming fearful. As we have experienced during the coronavirus pandemic, markets can be volatile – and even negative – on any given day, week or month, and can be affected by a range (or even a combination) of political events, natural disasters, trade wars, global health crisis or war.

Food for thought: ‘Every once in a while, the market does something so stupid it takes your breath away.’ (Jim Cramer) 

Diversification

Having a diversified investment portfolio is a key pillar of long-term investing and is a powerful tool for reducing risk in your portfolio. Through careful asset allocation, investors are able to spread their money across different asset classes and industries, all of which have their own risk profiles and potential for return. By diversifying your investments, you are able to offset losses in one asset class and/or industry against the other as a form of risk management. Bear in mind that diversification cannot prevent risk – it can only serve to mitigate risks that an asset class or industry can be exposed to, such as natural disasters, interruptions to supply chains, trade wars, global pandemic, or technological advances.

Food for thought: ‘The only investors who shouldn’t diversify are those who are right 100% of the time.’ (John Templeton) 

Rand cost averaging

Investing from an early age is not only about compound interest. It’s also about the benefits of making consistent contributions to your investments at regular intervals – otherwise known as rand cost averaging. Rand cost averaging allows investors to consistently invest in vehicles with fluctuating prices, such as shares or collective investments, allowing investors to build long-term wealth without the risk of poor market timing.

Food for thought: ‘The individual investor should act consistently as an investor and not as a speculator.’ (Ben Graham) 

Starting early

The costs of delaying investing are well-documented although cannot be overstated. Time is the mechanism which allows compound interest to work its magic. A longer investment horizon allows you to take more investment risk, enjoy the benefits of rand cost averaging, and grow your wealth exponentially for future benefit. It also allows you to take advantage of the tax benefits on retirement fund contributions during your income-generating years.

Food for thought: ‘I made my first investment at age eleven. I was wasting my life until then.’ (Warren Buffet) 

Managing emotions

Investment markets are a roller coaster of highs and lows, fear and greed, exuberance and panic. Making investment decisions through an emotional filter generally leads to poor decision-making. That said, staying calm while the markets ebb and flow daily, weekly and monthly is never easy, especially if you are drawing a fixed income or close to retirement. Our emotions are further shaped by our biases, which include overconfidence, the fear of missing out, overreacting and confirmation bias – all of which serve to blur our decision-making. The unpredictable nature of markets should not be allowed to influence our emotions. Ideally, find an independent advisor who can partner with you on your investment journey and guide you through your emotions as an investor.

Food for thought: ‘The markets are unforgiving, and emotional trading always results in losses.’ (Alexander Elder)

Food for thought: ‘Lower costs are the handmaiden of higher returns.’ (John Bogle) 

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