As a first-time investor, investment options and industry jargon can be somewhat overwhelming. However, understanding the key principles of long-term investing is essential for any new investor wanting to create sustainable wealth. Before you start investing, there are some things you should know.
Starting can be the hardest part
At the outset of your career, it is difficult to visualise a retirement that could be 40 or more years away. With such a distant goal, it may be difficult to find the motivation to start investing – especially when you have more pressing financial needs and an entry-level income. As a young professional with relatively low earnings and few assets, you may also feel the services of a professional adviser are not warranted. Further, many investment platforms stipulate a minimum monthly investment premium of R500 which may lie outside your affordability. A combination of these factors may make it difficult to begin your investment journey. However, there are many ways to enter the investment markets and the best approach is to find an independent adviser who will come alongside you to help you start your investment journey, regardless of your level of affordability.
What the investment experts say: ‘Do not save what is left after spending, but spend what is left after saving.’ (Warren Buffett)
Compound interest is magical
Compound interest, or compounding interest, is interest calculated on the initial principal including all the accumulated interest – thereby creating a snowballing effect when it comes to accumulating wealth. Because of the power of compound interest, even an average saver can amass sizeable wealth over time. To make compound interest work for you, you will need some money to invest, an investment return that beats inflation, and time. Once you start investing (even it it’s a relatively small amount) you will continue to earn interest on your interest as time goes by – making time the most important part of the compounding equation.
What the investment experts say: ‘Time is your friend, impulse is your enemy. Take advantage of compound interest and don’t be captivated by the siren song of the market.’ (Warren Buffett)
You need a game plan
Where and how you invest is dependent on what goals you want to achieve through the process. For instance, if you want to put money away every month to save up for a deposit on a house within the next few years, your investment strategy will be completely different to the one you employ to save for your retirement. Investment goals must be measurable, rational and in line with your lifestyle objectives. They should also take into account your personal propensity for risk, the returns you need in order to achieve your goals, and the length of time you intend investing for. Whatever your short-, medium- and long-term goals are, take time to write them down and then find an adviser who can put a workable plan in place.
What the investment experts say: ‘All success is, really, is having a predetermined plan and carrying it out successfully over a long period of time.’ (Harvey Mackay)
Timing the markets doesn’t work
Trying to time the stock markets is a bit like jumping shopping aisles to find the shortest queue – only to get stuck at the till with the slowest teller whose scanning machine packs up just as you reach the front of the queue. The reality of investment market performance shows that between 80% and 90% of all the returns realised on the stock exchange occur between 2% and 7% of the time. This means if you’re out of the market when stocks start to perform, your portfolio is destined for under-performance. Nobel laureate William Sharpe’s research found that market timers must be right an incredible 82% of the time just to match the returns realised by buy-and-hold investors. Investment gurus such as Warren Buffett, Peter Lynch, Walter Schloss and Shelby Davis have long touted the investment virtues of the buy-and-hold strategy.
What the investment experts say: ‘Market timing is unappealing to long-term investors. As in hunting deer or fishing for rainbow trout, investors have learned the importance of ‘being there’ and using patient persistence — so they are there when opportunity knocks.’ (Charles Ellis)
Tax is inevitable
Understanding how your savings and investments will be taxed is empowering and will undoubtedly lead to better financial outcomes. As an investor, you will want to save in the most tax-efficient manner by minimising the tax payable and maximising your tax benefits. Different tax structures apply to different investments and it is important to understand the tax implications of an investment before implementing. For instance, tax-free savings account premiums are not tax deductible, but the interest earned on the investment is tax exempt. On the other hand, premiums towards a retirement annuity (up to 27.5% of taxable income subject to maximum of R350 000 per year) are tax deductible. While no tax is paid on the capital growth or income in an RA and no CGT is paid on disposal, tax does apply to any lump sums taken as a withdrawal or at retirement. Tax is payable on income generated from a unit trust investment and if you dispose of underlying shares you may be liable for CGT.
What the investment experts say: ‘A person doesn’t know how much he has to be thankful for until he has to pay taxes on it.’ (Ann Landers)
Markets are volatile
The stock market is a complex system of large and small investors making decisions about a wide range of investments. The market is driven by the supply of shares people want to sell and the demand for shares that people want to buy. The nature of investment markets is that they are volatile and subject to short-term fluctuations, making timing the market incredibly difficult to do. However, over the long-term, investment markets are excellent for investors wanting to achieve real returns over time. Wars and conflicts, government fiscal policies, natural disasters or extreme weather, and technology disruptions are just a few things that can affect investment markets in the short-term. Having discipline and long-term investment goals will help you drown out the short-term market noise.
What the investment experts say: ‘Every once in a while, the market does something so stupid it takes your breath away.’ (Jim Cramer)
Diversification is your friend
Diversification is the cornerstone of portfolio construction and is based on the principle ‘don’t put all your eggs in one basket’. Diversification is a management tool that allows investors to spread investments to avoid hedging their bets on a single asset class, currency or sector. As such, investors can spread their risk between local and offshore equities, local and overseas currencies, developed and emerging markets, as well as between various sectors such as mining, retail, technology and construction. It is advisable to partner with an expert to construct a portfolio that aligns with your needs, and to rebalance your portfolio in line with your mandate as and when necessary.
What the investment experts say: ‘Don’t put all your eggs in one basket.’ (Warren Buffett)
You are irrational
When it comes to investing, humans are not as rational as one would think. In fact, the sometimes irrational and erratic behaviour of investors has given rise to an area of study known as behavioural finance. Mounds of research has uncovered evidence that rational behaviour is not that prevalent when it comes to investing because human emotions tend to take over the decision-making process. Emotions such as fear, greed and panic can lead investors to make knee-jerk decisions in response to short-term market fluctuations – often with detrimental effects to their investment portfolios. Investor emotions are driven by a range of biases such as over-confidence, loss aversion and mental accounting. Key to becoming a more rational investor is learning to identify your biases and to avoid them impacting your investment decisions.
What the investment experts say: ‘Investing isn’t about beating others at their game. It’s about controlling yourself at your own game.’ (Jason Zweig)
You have to take risk
As an investor, it is essential to understand the relationship between risk and reward. The higher the relative risk of an investment, the larger the possible returns may be. For instance, cash is considered a low risk investment while equities present a higher level of risk. What is important to note is that risk is never completely absent, and returns can never be guaranteed. For these reasons, it is important that each investor understand his own propensity for risk before investing. However, the reality is that if you want your capital to beat inflation, you are going to have to take some investment risk. Finding the most appropriate level of risk for yourself involves balancing your portfolio, understanding your financial personality and giving consideration to your investment timeline.
What the investment experts say: ‘How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.’ (Robert G. Allen)
Investments come at a cost, and these fees are generally charged as an annualised percentage including investment management costs, advice charges and administration fees. Costs can significantly impact your investment returns and it is important to have full, upfront transparency of the fees you are being charged. When analysing your fees, it is important to determine the difference between upfront fees (such as a financial planning or implementation fees) and ongoing fees (such as advice and administration fees). Over time, investment fees can have a significant impact on your investment’s growth, so it is advisable to shop around for favourable, market-related fees. Having said that, bear in mind that an experienced financial adviser can add significant value by helping you set goals, structuring your investments, minimising your tax burden and regularly recalibrating your portfolio. His fees should be fully disclosed upfront and should appear separately on every statement.
What the investment experts say: ‘The stock market is filled with individuals who know the price of everything, but the value of nothing.’ (Phillip Fisher)
Have a fabulous Wednesday!
Categories: Financial Planning