A tale of some money
Most of us don’t think twice about opening our wallet and handing over cash or plastic. Perhaps we think this is just a form of barter, you give me something and I will give you something back of equal value – and money is just one of those ‘things’ we can barter with. I suspect we think that all that money is backed by investments in the bank in one shape or form. Not so. In effect banks ‘create’ the money but it is ‘leveraged’ – in other words they don’t lend out R1 for every R1 they have in investment but much more than this. The degree to which they can leverage themselves (lend more than they hold) is controlled by their ‘capital requirements’ – an amount that has increased over recent years following the credit crisis fall-out. You’ve probably heard of QE or quantitative easing. This a monetary policy governments use when ‘normal’ monetary policy (interest rates) fail. Basically, with QE governments buy bonds from financial institutions to increase their liquidity in the hope they will lend out the money and get the ‘Money-Go-Round’ going again. In other words pushing it out of it’s inertia and give it some momentum so it can go around by itself. Unfortunately this has had limited success, mostly because the banks aren’t getting enough of a ‘margin’ (aka profit) because of historically low interest rates. Banks have also been inefficient and are now having to use technology to become more competitive – and have been haemorrhaging jobs as a result.
Let’s illustrate this “Money-Go-Round” with a short tale:
In a small dorp in Limpopo, a German tourist walks into the local B&B and puts R500 on the desk. “I want to look at your room upstairs and maybe I will stay here, Ja?”
“Sure,” answered the owner, Jacob, handing the tourist the key to the room.
The tourist heads upstairs and Jacob looks at the money on the desk. “What if he doesn’t stay?” he thought to himself – fleetingly – before picking up the money and heading to the liquor store next door and settling his long overdue account so his supply would start to flow again.
The Liquor store owner looked at Jacob and the money in surprise, but smiled his thanks and placed it in his pocket. Once Jacob was out of the door the liquor store owner walked across the street to pay the hairdresser’s account that his wife had clocked up on her last visit. She, in turn, closed up the shop, flicked the ‘back in 5’ sign and went to the petrol station and paid her account there.
Expect the unexpected: The polls in the USA got it seriously wrong – why? It is only a sample of the population and people lie! Few (sane?) people will publicly admit to endorsing the racism, bigotry and misogyny espoused by Trump but when it comes to the secrecy of the ballot box, it became obvious that there were millions of closet Trump supporters. This has ushered in a whole new world of uncertainty, just like the Brexit vote did, and just like Nenegate did here. It has taken us nearly a year to recover from Nenegate, and the UK is still shuddering. When it comes to your wealth – protect your risks, diversify every aspect of your wealth.
Populism is here to stay. The protest vote against the status quo in government is turning the tide everywhere, including here. Brexit is a good example (trust the Americans to one-up the Brits! This result is Brexit to the power 10). This outcome is a result of emotion and not reason. “We, the people” are sick to death of lobbyists, special interest groups, bloated government payrolls, erosion of real purchasing power and having to reskill into new jobs. The only voice that growing ‘disaffected’ group has, is to vote for something different, however nauseating that might be. The major threats? If you work for, or supply to, government- diversify and seriously reduce your risk exposure. Opportunities – Small business, the Health industry, Service industries, On Demand, Customisation.
It’s not cool to be clueless: Hillary’s email fiasco hit her hard and should be one of the biggest lessons anyone, of any age, needs to learn. If you refuse to climb on the technology bandwagon, and keep up with it you’re going to get hurt. As a retiree your banking costs will climb, but more onerous than that – you will open yourself up to being conned and taken advantage of. In your working life you will not be able to be as productive as someone who embraces technology – forced early retirement is calling! Most of the growing jobs and professions require a good understanding of technology. This is even more true of ‘passive’ income opportunities. Keep your work and home social media presence separate.
Investment Diversity is as important as Biodiversity
One of the constant features of us complicated humans is the desire for diversity. We get bored quickly. We want new tastes, new experiences, new ‘stuff’. As soon as anything becomes repetitive we lose interest or get stressed. Repetitive jobs, reruns of old TV shows, repetitive ads, poor menu choice at your favourite restaurant. Fashion is a direct result of our need for variety. In nature this variety is called biodiversity.
Biodiversity is extremely important for the planet. It allows for flexibility when change happens to an environment. That change may kill one or two species, but something will always survive – even if it is just a cockroach or Trump. When it comes to our wealth, diversity is just as important. You cannot afford to put all your retirement eggs in one investment basket.
So let’s look at the various components of wealth and see where the diversity can come from:
There are 5 asset classes: Cash, Bonds, Equity, Property and Currency (not a classic asset class but a multiplier for offshore investments).
Cash is pretty self explanatory. It is ‘boring’ and gives you a below inflation rate of return. It’s importance to your wealth however cannot be underestimated. Cash-flow is king, not just for businesses but for individuals too. If you have cash available you can weather unplanned expenses without taking out expensive debt. You can also take advantage of other wealth opportunities quickly and without eroding your other wealth caches. If you put your cash with a major financial institution or in a product that spreads the risk across a number of institutions you are going to be okay. You are unlikely to lose the capital. What percentage of your wealth portfolio should be in cash? This is going to vary according to the economic environment but 3 months, after tax household expenses plus 10% is a reasonable rule of thumb. This is right across your wealth portfolio. Your retirement fund for example will have at least 10% in cash – but is ‘unavailable’. If you have a ‘blended’ unit trust (a flexible or moderate mandate for example) then there is probably a cash component there too.
It’s in their behaviour, not luck
1. They know their limitations. Investment is complicated, even new financial advisors will shy away from giving investment advice or recommend safe, well known funds. The more you know about investment though the scarier it becomes – but that is way better than thinking you know everything. There is nothing like being unconsciously confident. Unless you’re prepared to spend a considerable portion of your week keeping up with the global trends, tax implications, regulatory changes, economic indicators etc get a trusted advisor to give you a hand. That advisor can do due diligence on the Unit Trusts or Shares that you buy, investigate the fees on the platforms you use, investigate the investment philosophy of the asset managers you want to use, divert your funds into the right types of investment and alert you to macroeconomic changes. I know that paying your advisor a fee is a grudge, but regulations are changing to make it a win-win. In return for that fee you are entitled to feedback and ongoing monitoring of the appropriateness of that investment. As much as a fee will erode the investment, believe me, a park-and-leave approach to investing can be even more dangerous. I continually come across investments that have been in place for 20 years or more and not even keeping up with inflation.
2. They know that you can’t buy respect: Keeping up with the Joneses is probably one of the most toxic behaviour traits when it comes to wealth accumulation. Wealth is what is left after you have consumed your income. It is as simple as that. There is no point in seeing yourself as a smart investor if you don’t leave yourself anything to invest with at the end of every month. If you worry what people will think about the car you drive or the house you live in, perhaps you need to spend some time with a shrink or a coach and not on property.com or going for test drives? Read more
How to make the most of it
With Prime at 10.5%, and likely to rise further this year, your returns from cash (and bonds) are going to be better than they have ben for many years, and will almost certainly be less volatile than the stock market. So how do you take advantage of this – but not lock yourself into something for years?
- Maximise your interest tax deductions. Your annual tax certificates (IT3) will be coming in over the next few weeks – are you maximising your R30k annual deduction? If you are, look at tax free savings accounts (max R30k contribution pa).
- Use ‘cash’ and ‘bonds’ to moderate your portfolio if you need to preserve your capital in your investments. You may also want to moderate your portfolio and still get a decent return if the wild fluctuations of the stock market is making you ill.
- Pick a savings pocket that gives you decent interest for your emergency fund. Shop around – you might be surprised how much they vary. If you’re a frequent traveller having a Visa and a Mastercard might be prudent – in some countries you cannot rely on both being available all the time. Factor that into your choice of savings account.
- Kill as much debt as possible, starting with the most expensive – credit cards and personal loans. Interest rates on these products run over 18% – you’re not going to get that guaranteed returns anywhere else. Sure, you aren’t ‘getting’ interest but you’re saving having to pay it – and you don’t have to pay tax on it! Your bond is the last of the ones to throw money at, because it is the cheapest, but once the others are gone, a great place to ‘invest’ your money. Wealth is what is left when you have ‘consumed’ your income. It makes no sense to pat yourself on the back when you add interest to your income when it is consumed by interest you’re paying over the odds for on the other side of the equation. Focus on the bottom line, your wealth, not your income.
- If you absolutely have to move house, be very careful about the size of the bond you take on. Will you be able to afford it if the interest rates rise 3, 4, 5% ? Moving house frequently is one of the biggest wealth killers – examine your motivations really carefully. Maybe you need a few sessions with a shrink or coach and not a new house.
- New cars are another black hole that can suck the life out of your wealth – the same things apply to them as to houses. The biggest favour you can do your long-term wealth is to separate your ego from cars, houses and keeping up with the Joneses.
- Should you fix your bond? Tip – when financial institutions start offering to fix your interest rate ( always above the prevailing rate) you can bet your bottom dollar they are about to drop. Right now, that ship has sailed.
- If you’re retiring, consider taking out a ‘life’ annuity and not a ‘living annuity’. This is even more pertinent if you’re single and it doesn’t matter that the investment dies when you do. A ‘life’ annuity gives you certainty on your income that a ‘living’ annuity cannot. The interest rate that you ‘buy’ your life annuity at stays with you for life. Those pensioners who took out life annuities when interest rates were at 20%+ are laughing today. Factor in inflation though – it costs you more but rampant inflation can very quickly erode that fixed income.
Action: This is a good time to focus on the ‘asset allocation’ of your investments, maximise your tax deductions and mitigate some of the volatility in your portfolio if you need to preserve that capital in the short term.
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Author Dawn Ridler ©
The Passive revolution
All over the world investment fees have fallen substantially, not just as a result of lost trust in investment bankers’ post 2008, but with the massive increase in the use of ‘passive’ funds that use cheap computers instead of expensive asset managers to structure long term portfolios. In other words they just follow what the stock market is doing and don’t try and get clever and ‘beat’ the market. The losers are the ‘mutual funds’ what we call Unit trusts or collective investments here in RSA. Gone are the days when asset managers could get away with fees of up to 3%. Passive investments usually come in below 0.5%, and some even lower than 0.3% and we haven’t seen the bottom yet. Why are we in SA dragging our heels to keep up with this global trend?
One answer could lie in our much higher inflation for the fees to hide behind. If you take 3% off a 10% growth you’re still getting 7%. Factor in inflation of 6% and the real growth is only one percent. It looks very different to taking 3% off a 5% growth ( which is in line with the kind of growth they have been experiencing in the West), their inflation is still around 1%, so the nett effect is the same – but the perception by clients is way different. Basically we have been hiding behind double digit growth. Investors are happy to share in times of good growth, but when things swing down they aren’t quite so magnanimous.
The trend to lower cost passive investing has already started in earnest and clients that are following offshore trends are (rightly) insisting on these lower fees, especially for long term investments like retirement funds.
Performance fees – which are essentially hidden – are another bone of contention and the government has woken up to the problem and started to demand ‘clean’ pricing (without the dirty performance fees) for retirement funding, starting with the Tax Free Savings accounts. Performance fees have a number of issues. Firstly they are imposed on future performance based on past performance. In other words, new money coming into the fund has to pay the fee despite not having enjoyed the return in excess of the benchmark. Secondly, some collective investments build their own benchmark – making it impossible for you to compare apples with apples. It’s like doing your own performance review.