Harmony is not an accident
Abdicate, Delegate or Micromanage – what is your investment style?
There is a good reason Richard Thayler won the Nobel prize for Economics, the academics have woken up to the fact that the only sane explanation for the messed up financial markets is that humans are driven by something called emotion, and until you understand that, you’ll never understand what makes markets tick. (Personally I found Thayer’s book ‘Misbehaving’ boring and indulgent, but those are key ingredients for an academic best seller. ‘Nudge’ was an easier read, but a single (excellent) concept fluffed out into a full book.)
So, how do you manage your wealth, assuming of course that you’ve managed to consume less than you earn so that there is actually something to invest? If all your disposable income is going into debt servicing then I suggest you need to take a step back and address that first. There is no point in investing at CPI plus 3-5% when the interest you’re paying on credit cards or personal loans is running at CPI plus 11-25%. The only ‘good debit’ out there is at prime, or less (10.25% and below) – like your bond. We can look at your investment style three ways, abdication, delegation and micromanagement.
Sorting out your messy investment garden
I am a keen gardener and love having colour and diversity all year round, but because there are plants that hide in summer (the spring flowering bulbs) and others that hide in winter (like my awesome voodoo lilies) it is often a mission to know where everything is and why I put them there – and far too often I used to dig a hole for something new, only to destroy a hibernating bulb. Mercifully, this doesn’t happen anymore since I put a low tech and high tech organizational system in place.
Investments are no different. If you don’t know where all your investments are, the objective of each investment and how they’re doing at least once a year, it’s unrealistic to expect them to flourish. Having said that, just like you don’t have to watch your plants every day, fund changes or portfolio changes don’t have to happen all the time, but only when macroeconomic changes dictate it or there is a significant change in your finances.
Having an ‘objective’ for your different buckets of investment is key. That objective will tell you what asset classes to use, how long the investment is going to run, what portion should be offshore, what tax vehicle is most efficient and what sort of return you can expect. With no objective, it is like buying a plant at a nursery blindfolded and just sticking it anywhere in the garden and hoping it grows into a fabulous strawberry patch – meanwhile it is a slow-growing baobab and is going to be killed off in the first frost.
Your biggest medical risk? The NHI (National Health Insurance)
As if it wasn’t enough that Medical Aid premiums have been consistently increasing well above inflation for years, the National Health Insurance (NHI) government proposals that have been on the backburner for years are now a hot topic. Why now? For a start it is a popular move that will play well to the voting public (with elections less than 2 years away), secondly there is a perception that, with the billions being thrown at SAA or SABC, there is spare cash floating around (especially if they start tapping into the PIC – government pensions.) Of course, the NHI also has its eyes on the R20bn in medical aid tax credits given to us taxpayers, and it is quite possible that this is going to disappear – as soon as the next budget in February 2018. This R20bn is actually a drop in the ocean – in 2010 the cost of the NHI was estimated at R450bn pa (for cover equivalent to the Government Employees Medical aid known as GEMS). It may take another year or two before the NHI becomes compulsory, and it will likely start as a ‘lite’ version but it makes sense to start anticipating it now and aligning your costs accordingly.
Knowledge is power
The Life Insurance industry has tried very hard to shake off the stigma of the past. The products have improved, costs come down and the advice jacked up (thanks in part to much stricter regulation). It has also become highly competitive and diversified, making it almost impossible for the man in the street to make an informed choice, relying on a Trust Advisor to help them with that. The new regulations, the ‘Retail Distribution Review’ (RDR), is going to protect consumers even more, but it is also going to force lower income consumers to do it themselves via Call Centres or direct sellers, as Brokers, Advisors and Planners decline to do ‘small’ policies because the remuneration just doesn’t even cover the costs.
There is another issue, money is tight and everyone is shouting “Pick Me” trying to get their hands on your disposable income, insurance salesmen and investment specialists among them. Cutting through the bull that you’re bombarded with in SMSs, Social media ads and TV commercials that lure you in with statements like “all your premiums back if you don’t claim”, “cut out the middle man and save” or “get R1m life cover for R1 a day”. (All the claims are fundamentally flawed if you read the small print – but that’s another story). Life cover is one of the ultimate grudge purchases, but most of us do it because it is the responsible, grown up thing to do, and we just keep on doing it. This is an important decision, if you make the wrong choice you may not be able to change it if you’ve had any event ( even a relatively minor car accident) that will impact your insurability. Is it money well spent – and should it be for life?
Over time overgrown plants and dead wood will accumulate in your garden, and if ignored can kill off everything around it. It doesn’t matter how carefully things were planned at the start unless that plan is revisited and maintained, you can end up with a weed filled jungle that is almost impossible to get back into shape. Spring cleaning is not about throwing everything out, it’s about pruning, splitting, composting so that it will look better in the future. So… Using this botanical analogy, what can you do about your wealth portfolio?
Pruning: This is the cutting back of plants so that you get a better flush in the next year. Just like you should prune roses and fruit trees every year, so should your wealth portfolio be examined and trimmed every year to maximise its potential. Wealth is what is left when you have consumed your income – the simple Wealth Equation. The Consumption side of the Wealth Equation is where you need to prune. Use your banking software or a free app like 22seven to see where you need to prune. Everyone is going to be different so it is difficult for me to say what is important or not. If you’re not sure, list all your expenses for a month then put a priority rating of 1 to 5 next to them, the order that you’d drop them if you absolutely had to, with 1 being the most important. Put everything there including your mortgage, car payment, medical aid. Some people would rather eat baked beans for a month than drop their DSTV subscription for example.
Pinching out. This is the mini-pruning of shoots so that the plant will bush out and produce many more flowers or fruit – increasing your ‘harvest’. Fuchsias are an excellent example of this. Pinching out effectively delays the flowering or fruiting of the plant – delayed gratification for the greater good. Take a topiary for example, getting a pleasing shape depends on knowing what you want it to eventually look like (an objective), and having the patience to keep controlling it until you get there. If you want to increase your harvest you need to have as many points of diversity as possible, so that if one branch dies, the other branches can pick up the slack. All portfolios should have an objective : What are you going to use the investment for and when? This timeline will dictate how you should treat the investment, and how important it is to preserve the capital. Probably the biggest capital accumulation you’re going to need to make is for your retirement, but how big this pot needs to be will depend on what you want your retirement to look like (in present value terms). This calculation is far too important to ‘wing it’, get professional help.
Compost and Fertilise: Over the year plants deplete nutrients out of the soil to produce leaves, flowers and fruit, if you want them to keep on producing you need to compost and fertilise. Your wealth portfolio is no different. You can compost it ‘organically’ with interest and dividends that are ploughed back into the portfolio – or inorganically by adding to the portfolio with new, man-made (you-made) contributions. Most of you probably already contribute to some sort of investment every month, but what do you do with your bonuses? Why not commit to putting 50% of that bonus into investment. You could also do this with other little windfalls like Insure cash payments or other loyalty program paybacks. The free app Stash# will also make it easy for you to get that money out of your pocket before it burns a hole.
The one thing standing between you and financial security is in your head
Why is it that you find teachers that are financially secure all their lives and retire comfortably but CEOs earning 100 times more aren’t in the same place? It all boils down to one thing, spending less than you earn and investing the rest – for decades. Sounds simple right? Why is it then that so many people just can’t get it right? Essentially it has to with what is going on in our head. Our spending or saving habits are a result of years, often decades, of behaving in a certain way. Every time you behave in that way, the habit is ingrained in your psyche and changing it to get better outcomes very difficult. Difficult, but not impossible.
When you want to change a habit you can do it cold turkey or by taking baby steps, the method you choose is up to you but the problem with ‘cold turkey’ is that, unlike smoking or drinking, you still need to spend money. This is not unlike dieting, you have to eat to live, so you can’t just cut out all food. Crash diets rarely work in the long term, because the basic habit that caused the weight gain hasn’t been changed – changing poor financial habits are very similar. Slow and steady usually wins the race.
So, let’s take the principals of dieting and apply them to changing your spending habits.
- Know what you’re consuming. I hate to use a new-agey buzzword word but by becoming more ‘present and aware’ of what you’re doing with your money you will bring you closer to a better financial outcome. In the (good) old days it is the equivalent of not balancing your cheque book and leaving your envelopes of statements unopened. Today it is not much different, it is just all digital. The good new with that is that you can get the technology to put it in your face so you can’t ignore it. I am sure you’ve tried to have a ‘budget’ many times in the past, but they are time-consuming and depressing. Free apps like 22seven make this dead simple today, but you have to interact with it, set the categories and limits and watch the notifications when you’re going over your target. Make friends with your money. Start watching what is going in and out, and make your own assessment if that is helpful, that change alone will start to change your behaviour.
- Cut out the carbs. These days fat is good, carbs are bad – but either way, when you’re dieting you have to moderate the food-to-mouth disease if you want to lose weight. Once you’ve made friends with your money and put your consumption into categories you’ll soon find your weak spot (if you didn’t know it already). If you’re lucky, by watching your consumption you might also find long forgotten debits that can be killed off. If you’re paying for a loyalty program and not using the benefits, that alone can save you several hundred Rand month. What about bank fees? If the bank’s loyalty program isn’t virtually paying for that every month, look at changing banks. Use loyalty programs to their max, I personally get around R2,500 a month back on mine – and I am not talking about discounts.
- Don’t have the food in the house. In financial terms, having the bank/credit card instantly available – even embedded in your cell phone – makes it much too easy to consume. Show your brain something it can understand – cash. Once you have identified your weak spot, or the place you think you can save money, take the month’s allowance out in cash and stop using the card. Many banks allow you to get ‘cash back’ at the grocery till which costs you a fraction of using an ATM and is way safer. If you have cash left over at the end of the month then spoil yourself with a little treat or take out less next month and move the balance into savings.