There is no doubt that people are different, and a perfect example of this is when it comes to using a road map or assembling a piece of furniture. Where there’s more than one person involved, there will usually be at least one holding the road map or the set of instructions, while the other chooses to figure it out himself/herself, with no help and no opinions from others.
Many investors use the same approach when it comes to their personal investments, and they choose not to follow any guidelines, simply because it appears to be too complicated. But there are in fact simple guidelines that investors can follow, especially when compiling their own investment portfolios.
Step 1: Speculators are not investors
According to historical data (which is no promise for future performance), equity investments still deliver the best returns over the long term. An investor that decided to invest in the JSE Stock Exchange in May 2008, for example, when the market reached an all-time high, but was also on the verge of one of the biggest ever corrections, and held on to his investment until the end of July 2020, would have earned 141% growth on his investment. And this despite two of the greatest corrections of all time, the Great Recession and the more recent COVID-19 pandemic. Would that have been phenomenal growth? Not necessarily, but what it shows us, is that despite some of the worst times that the SA market has endured until now, that investor still would have been able to beat local inflation by 2% per year with his earnings.
Step 2: Diversify
It remains a simple concept, and yet I see so many investors struggling with diversification, mainly due to personal preferences and emotional involvement. The fact remains, however, that capital loss hurts – not protecting against it. One investor may have lost capital value in shares over the short term and may have decided to only focus on money market going forward, while another investor may have had so much luck with his property investments, that he now refuses to ever consider another type of investment again. Historical figures show that diversification, or the spread of capital across different types of investments, not only reduces risk, but it can also provide better returns.
Step 3: Focus on time, not timing
Due to the fact that share prices fluctuate constantly, many speculators would have become incredibly rich if they had bought when share prices were at their lowest, and sold when share prices were at their highest. But if that was as easy as it sounds, I probably would have written this somewhere on a powdery white beach on a tropical island and definitely not in my office. The fact is that even the biggest and most successful investment experts cannot get it right 100% of the time, and this can be seen quite clearly in historical returns. As an example, only 15% of General Equity Unit Trusts managed to outperform the FTSE/JSE All Share Index’s total returns over the past 3 years, and this includes returns from passive funds such as ETFs.
Step 4: The power of compound returns
This concept requires roughly the same amount of self-control as not using the brand-new credit card you just got in the mail. The investor that managed to exercise self-control over the last 25 years, for example, by investing R1 000 in shares in 1995, would have had an investment worth R23 256 today. If the same investor had withdrawn from his investment on a regular basis, let’s say 10% every year, things would look drastically different as he would be left with only R2 545 today. It’s easy to understand why Albert Einstein claimed that compound growth/interest (growth earned on growth) is one of the most powerful forces in the universe.
Step 5: Invest in what you know
Don’t look at your investments as just figures on a page. If you want to invest in shares, make sure that you invest in good reputable companies, and make sure that you know these companies well. You should know where your money is going and you should know your investments. If you’re unsure, rather consult a professional to guide you. As I have said to my clients so many times before: No one cares more about your capital than you do.
The opinions expressed in this blog are the opinions of the writer and not necessarily those of PSG. These opinions do not constitute advice. This is intended as general information and does not form part of any financial, tax, legal or investment related advice. Although the utmost care has been taken in the research and preparation of this blog, no responsibility can be taken for actions taken based on the information contained in this blog. Since individual needs and risk profiles differ, it is always advisable to consult a qualified financial adviser before taking action.