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Investing vs speculating

The discipline of investing in well thought out and proven strategies build your wealth solidly.

For this article, I really want to step away for a while from the Covid-19 discussions and predictions about how the virus is going to affect the economy.

So, I thought I would go back to investing 101.

I was recently sent a question by a publication, posed by one of the readers which asked whether it would be prudent at this time to access capital out of mortgage bond of a rental property and invest this capital offshore?

My response was appropriate, but it got me thinking about the difference between investing and speculating. In my mind, the reader’s question was going into the realm of speculation rather than a disciplined investment strategy.

I have been a member of the investment industry for over 25 years now and it always amazes me how the human condition ensures that we lend our ears to those who have supposedly achieved the impossible.

You know the stories I am talking about, the ones you hear around the braai on Sunday with a beer in your hand. Where there is always a person talking about how their friend has made a huge return in (fill in the right investment here) and are now billionaires buying four-storey homes in London, Italian sports cars and a boat, just off of this one “investment”.

My first thoughts when hearing such stories are that:

(a) This person is usually the loudest at the braai/bar/party and usually the one that has had way too many beers;

(b) He/she is out to try and impress the rest of us because they know the coolest people;

(c) They probably don’t actually know this person and this is a third or fourth hand story; and

(d) They do not know what happened long before this particular investment actually paid off. This is similar to those stories told by the gambler who recounts how much they won at the casino the night before but, never tell you how much they lost the five years prior to this last win.

What I have learned over 25 years in the business is that investing is serious business.

You can compare investing to your personal wellbeing– healthy eating and going for your bi-annual dental check-up – investing is a discipline. A discipline where, like personal fitness, the daily gains are marginal. Sometimes when you look up, you think: Is this all I have done? But if you carry on, slowly you see the results, then one day you realise how far you have come along this path.

Then finally the realisation is there, that because you have achieved growth on your capital and now the amount you have grown your capital by is growing. I like to call this stage “the quickening”.

When one gets to “the quickening” stage this is where investing gets interesting. If, at this stage, you have enough capital put away so that no matter what life throws at you, you and your family will not feel the effects of unforeseen events too badly, then you can take a small amount of money, put it to one side (of the money you have already put aside, you take a small percentage of that money and put that small percentage aside … get it?), this small amount is the “money for speculative investment”.

In technical investment terms, the bigger part of your portfolio is often referred to the core of your portfolio and the tiny piece you are speculating with is referred to as a performance sweetener or even the satellite.

For example: Let’s take Mr A. He starts a monthly investment of R5 000 per month which grows at 7.5% per year to which he increases his contribution by 6% per year for 15 years:

Year no Monthly contribution Annual Contribution + Value from previous year Capital Growth 7% average Value at end of year
1 R5 000 R60 000 R4 200 R64 200
2 R5 300 R127 800 R8 946 R136 746
3 R5 618 R204 162 R14 291 R218 453
4 R5 955 R289 914 R20 294 R310 208
5 R6 312 R385 957 R27 017 R412 974
6 R6 691 R493 267 R34 529 R527 796
7 R7 093 R612 907 R42 904 R655 811
8 R7 518 R746 029 R52 222 R798 251
9 R7 969 R893 882 R62 572 R956 453
10 R8 447 R1 057 822 R74 048 R1 131 870
11 R8 954 R1 239 320 R86 752 R1 326 073
12 R9 491 R1 439 971 R100 798 R1 540 769
13 R10 061 R1 661 500 R116 305 R1 777 805
14 R10 665 R1 905 781 R133 405 R2 039 186
15 R11 305 R2 174 840 R152 239 R2 327 079

Disclaimer: This is a hypothetical example and should not be taken as investment advice. The growth on the above illustration assumes growth added at the end of the year and not accrued through each month of the year.

In this example; at the end of the 15-year period could Mr A put aside say R200 000 (about 8.5% of the capital value) and place this amount in say Naspers shares listed on the JSE, thereby perhaps boosting his return by achieving a quick 12% return on this small investment? Yes, he could. Would he be taking a risk on this capital? Yes, he would but, in overall terms, this speculative investment could very well boost the return on his overall portfolio, without risking the portfolio as a whole.

As the above example demonstrates, it is the discipline of investing all the time in well thought out and proven strategies that builds your wealth solidly. We all love watching movies about Wall Street bankers that do big deals, build their portfolios in leaps and bounds and then go out and buy themselves a jet.

The truth is though, most of the investment institution offices around the world are quiet, disciplined places of work where the brightest mathematical minds work on financial models which look at disciplined, responsible ways of growing your invested capital at the lowest risk level possible.

On the whole, investment institutions achieve the impossible. Think about it ….

Investment institutions have to achieve capital growth, by not risking your capital that is invested with them. We know by nature that investing can be risky, you must take some risk to achieve growth. Even in an interest-earning bank account you are taking some measure of risk. Guarantees are never really guaranteed.

I am a big fan of the of our avoiding the human factor strategy.

This strategy is methodical (in that it follows a proven method), where the probability of a listed company’s management team is measured by their probability of meeting the price-earnings ratio implied in their current share price. The strategy is solid, disciplined and actuarial in its thinking. There is no forecasting in the future business deals to be signed by that company, no insider knowledge that may or may not come to the fore. This is simply a good solid way to build returns over time.

In essence, by avoiding human biases when selecting shares, you are looking at the idea that if a management team has been successful in the past it will do so in the future.

The strategy believes that winning is an all-time thing not a sometime thing. Winning is a habit, unfortunately, so is losing. This thinking resonates with me. Winning is something you do all the time, by doing the right things all the time, making marginal gains all the time.

Avoiding the human factor investment strategy is not that strategy that is going to try and continuously pick the rock star shares of tomorrow. No, but by avoiding the human factor, you have a strategy that gives you those small gains every day, every year, slowly, solidly, by selecting those stocks that keep delivering earnings every year. It is the strategy that builds fitness and muscle memory in your portfolio. It is the strategy that lets you pass the ball to your teammate without looking, but you know that he is there ready to receive your pass every time. This is the strategy that makes your portfolio the champion it can be.

Like in sport one always marvels at how a champion team wins continuously, seemingly always being a step ahead of their opposition, always the best prepared, with the fittest, fastest and most skilful players in their team. It’s a thing of beauty! What we never think of is how the team got to that point; how did they get to be the champions they are. To understand that, we have to go back, way back to the childhood of each of those team members, where their parents identified a talent and helped that youngster nurture it. The coaches, teachers, talent scouts and mentors along the way. The early mornings out in the cold, training. The late nights at the gym, the strict diet, the times when the young team member is getting to bed early, when their counterparts are at a party chatting up the girls with beers in their hands.

It is the discipline, the focus on the goal and the small gains every day that leads these team members individually to where they are, where they finally find themselves together in being team members of that championship-winning team.

A solid investment strategy is the same, small gains made every day, and by following that strategy for long enough, one can take some small percentage of invested capital to speculate a little. To take a small calculated risk on not all, but a very small part of the total invested capital.

This speculation can be compared to that member of the championship sports team that knows that when he spots a particular small opening in the opposing team’s defence he can exploit it and put his team ahead (Think of former rugby Springbok Bryan Habana’s habit of intercepting the opposition teams passes and scoring tries against the run of play). If the Springbok team in which Bryan Habana played did not support these moments of his brilliance, there is no way he could have scored these spectacular tries. Just like your total portfolio cannot support a little speculation, unless it is properly set up and managed.

After winning a game, every champion sportsman or team all do the same thing. They spend a little time celebrating and then, it’s back to the training, back to the discipline, back to the marginal daily gains. If one watches professional cycling (one of the most gruelling sports) as soon as the winner of a stage crosses the line, he celebrates for a few minutes and then? It’s back on the stationary bike to get rid of the lactic acid build-up, it’s literally spinning the legs on very easy gears just to loosen the legs for the next day’s stage.

It’s the same in your investment portfolio, you have the big gain of that one speculative bet, that one nice deal that has paid off handsomely and then what do you do? You continue with the disciplined strategy, the same way of generating those small marginal gains, day to day at minimal risk levels. Keeping some money aside for that moment when the possibility of intercepting the opposition’s pass presents itself once again.

So, back to the discussion at the braai/party/bar, where the person telling the story is highlighting how exciting this acquaintance of theirs large profits are by taking a big bet on this or that opportunity, ask yourself, did they really take such a big bet or is the person being spoken about simply a disciplined lifelong investor who has reached a stage where they can take a small percentage of their total wealth and take a punt on something where the risk might be a little higher than their usual portfolio positions but in fact the size of this investment is, in this person’s total portfolio terms, insignificant?

Stay the course, stay focussed, stay disciplined, get the marginal gains, keep up the fitness regime, keep up the healthy and use the avoiding the human factor” investment strategy.

Oh, and one last thing, never believe what loud people around the braai or bar are saying, chances are they are bragging about exploits that never happened or they do not have all the facts in the story anyway.

Invest first, stay disciplined, follow the strategy, then, maybe one day, speculate.

Stay safe, stay healthy, stay inside.

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Mauro Forlin

Global & Local Asset Management

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