From diversification to compounding, Absa Multi Management's Kwaku Koranteng outlines investment principles that South Africans should keep in mind.
When looking back and reflecting on the course of events this past year, we have experienced some decent economic recovery after a horrendous 2020, although the Covid-19 pandemic has continued to wreak havoc in our personal lives. This global economic recovery has translated into a recovery in financial markets overall.
Still, the financial markets recovery has not been without some volatility due to the uncertainty about the virus, vaccination rollout campaigns, inflation, the global interest rate outlook, and financial and regulatory dynamics in China.
With this in mind, and as we head towards the end of 2021, investors are encouraged to keep a keen eye on their financial well-being.
This includes their investments, education planning, retirement planning and other financial matters.
Considering this, I would like to emphasise and remind investors of eight simple principles that every investor needs to remember.
1. Diversify – there is safety in numbers
As the proverbial saying goes: "Don’t put all your eggs in one basket", do not bet on a single or a few successful outcomes.
Academic theory and various studies have shown that by having your investment exposure in different securities that behave differently and not in unison, the fluctuations in the value of your investments can be reduced without compromising on the potential for achieving decent long-term returns.
Professionally trained investors such as asset managers, and at a further level of diversification, multi-managers such as Absa Multi Management who analyse and combine different but complementary investment managers, can assist investors in achieving the objectives of this principle.
2. You may live a lot longer than you think you will
The pandemic has been devastating and with this, it’s easy to forget that - over time - people are living longer than ever. As a qualified actuary, mortality tables have always grabbed my attention. Due to medical advances in society, we have seen improved mortality rates over time.
Scientists theorise that the first human being to reach the age of 200, since recorded history, has possibly already been born.
In developed markets and in some middle-income countries, longevity and declining birth rates are some of these countries’ most concerning long-term social challenges.
As such, your investments for income provision during the latter part of life need to account for this increase in longevity. Your potential retirement years are getting closer and closer to the average working career.
Investment strategies, for example, via exposure to risk assets that outperform inflation and investment products that can potentially help to manage longevity risk, such as guaranteed annuities or using prudent income drawdown rates, are important considerations.
3. Bad times in markets can be good for regular savers
Disciplined investors know that timing investment markets and securities is difficult and often impossible for ordinary investors to achieve successfully over the short term.
In addition, the outcome experienced from your investments ultimately depends on the initial price paid for the financial security and the price at which you exit. Bearing these two dynamics in mind, regular and frequent investments can assist an investor to avoid the pitfalls of market timing.
Over a 10-year period, if an investor misses the best 30 days of equity market returns, their investment outcome will be poor.
Rand cost averaging, the regular monthly investment into a unit trust, for instance, helps in mitigating these risks and capturing the timing opportunities and avoiding the guesswork. As an investor, this helps in avoiding buying securities at the top and cashing out at the bottom.
4. Inflation is the greatest threat to your wealth
"Inflation is the parent of unemployment and the unseen robber of those who have saved."
- Former prime minister of the UK, Margaret Thatcher, quoted in the era when the UK was experiencing debilitating inflation
At Absa Investments, risk management is integral to how we manage all our investments, and so to preserve wealth and grow it in real terms, we take on some calculated risks to enable your wealth to keep up and exceed the rising costs of goods and services over time.
This means having meaningful exposure to growth assets while balancing that with exposure to safer assets for those volatile periods. When planning for retirement, for instance, you could be saving 30 years away from your retirement day, and so focusing on inflation is critical.
5. Investment returns come from the power of compounding
"Compound interest is the eighth wonder of the world. He who understands it, earns it, he who doesn’t, pays it."
- Albert Einstein
Compounding is at the heart of investing. It means that when invested capital grows, that initial capital together with any growth already achieved, attracts further growth in combination. The longer the investment horizon, the better, as time is an investor’s best friend for compounding to work its magic.
6. The journey matters, choose a smooth ride
While every investor’s appetite for investment risk is unique, in general, investing in financial markets or certain financial products can be an emotional experience.
This is particularly true when money is lost, even when this is temporary. This may at times lead to sub-optimal investment decisions, such as cashing out at the bottom before a subsequent recovery and investing at the top of the cycle due to excitement, followed by a subsequent drop in value.
As a result, there are financial institutions such as multi-managers who aim to manage the risk for investors who may tend to choose the prior year’s top-performing investment manager, who subsequently goes on to underperform. Remember, if your investment loses 50% of its value over any given moment in time, a 100% recovery is required to get you back to your starting point.
7. Avoid chasing the next best idea
History is littered with bubbles and financial market crashes because of some investors’ exuberance about certain investments.
Often, and in retrospect, defying logic and investment fundamentals. The Tulip bubble in Holland in the 1600s is a famous one and, in recent memory, the dotcom and mortgage crisis bubbles.
Some would argue that cryptocurrency may show similar traits, though it is too early to tell, given the technological advances around blockchain.
Often, in these cases, investors would hear about the next big investment ideas from the media, friends, colleagues, etc. without paying attention to the investment fundamentals. It is crucial to align your investment goals with the optimal mix of assets to help you reach your goal, using professional assessment and techniques.
8. A small incremental increase in risk can boost returns
Finally, taking on incremental risk, when removing the risk that is specific to a particular security because of its sector or unique features, creates an opportunity to boost returns.
This is amplified over time as small but frequent and regular growth compounds over time.
Academic theory supports this idea through the idea of optimisation of investment portfolios. Investment managers and multi-managers such as Absa Multi Management achieve this through the diversification of securities and asset managers.