Investing is often a scary concept, particularly if you’ve never invested money before. A beginner’s guide might come in handy.
How to invest for the first time
The whole exercise is made even more daunting by the jargon used in the industry and the many different players involved. Let’s start with the people who actually manage the money – those who choose which companies and asset classes (cash, bonds, property, equities and international investments) to invest in. These are the asset managers or portfolio managers. There are two broad ways in which they can invest your money. One is to make ‘active’ decisions or bets on the future price of a share. A lot of research goes into trying to identify the winning companies, but the proof of success lies in whether they beat the benchmark or not. A typical benchmark is a market index, like the FTSE/JSE All Share Index. Research suggests that after all the fees and costs are deducted, only about 15% of active asset managers beat the market indices over five-year periods.
The alternative, cost-effective way of managing money is not to try to guess which shares will outperform, but rather to buy all the shares that make up a market index like the All Share Index, in the same proportions as they are represented in the index. That way you are effectively investing in the entire market and will earn the return of the market. This is called ‘index tracking’ or ‘passive management’. It comes at a much lower cost because asset management companies do not need to employ expensive portfolio managers to manage these portfolios.
Most asset managers offer investors unit trusts that pool the investments of many smaller investors and are then managed as a single account by the asset manager. Instead of owning shares directly, you own units in the unit trust that owns the shares. So, with small amounts of money you can gain exposure to a large number of underlying shares, all in a single product.
If you have some spare cash and are genuinely interested in buying shares, you can invest directly and skip professionally managed unit trusts.
The various types of unit trusts are differentiated by what they invest in.
The next player in the game is the stockbroker. Only a limited number of companies are licensed to buy and sell shares on the JSE. Every asset manager has to employ the services of a stockbroker to execute these transactions on their behalf. The fee associated with each transaction is called ‘brokerage’.
The third player is the provider of savings products and administration platforms through which you can access the skills of passive and active asset managers. Admin platforms are like supermarkets: they offer you access to many different unit trusts and savings products and charge a fee for doing so. Savings products include tax-free savings accounts, retirement annuities, preservation funds and living annuities. All these are legal ‘wrappers’ used as access points for investing in unit trusts. If you want to invest in many different unit trusts, it is worth signing up to an administration platform, which will consolidate all your investments in one place. They are called LISPs (Linked Investment Service Platforms) and most companies such as Allan Gray, Investec and Sygnia offer these. If you want to invest only in a single unit trust or the unit trusts offered by one asset manager, and you don’t want savings products, don’t bother with a LISP – go directly to the asset manager’s website.
The final player you need to know about is the financial advisor. There are two types, tied advisors employed by financial services companies like Old Mutual and Sanlam who will sell you only their employer’s products, and independent ones who can offer you a range of options as they are not tied to any one provider. If you’re paying for advice, make sure you only ever speak to an independent financial advisor. Robo-advice is a new generation of advice emerging around the world, including SA. These are internet-based tools that lead you to an appropriate investment solution by asking you a few financial questions. Some charge for the service; some don’t. Want to play around with one for free? Try Sygnia’s RoboAdvisor at www.sygnia.co.za.
If you have spare cash and are interested in buying shares, you can invest directly. In that case you need to open a stockbroking account with a stockbroker and instruct them on what you want to buy or sell and when. A stockbroker typically charges a monthly fee for administering the account, as well as brokerage every time you transact. Look for the cheapest stockbroker as all those costs can eat away at the value of your investments. However, remember that you are always at a disadvantage to professional asset managers in terms of information. So unless you have time on your hands, it is not an approach I’d recommend to the average investor. Also, if you do invest directly, do it with spare change and not your main savings.
Once you understand the players, you need to understand the game. When you save, your main aim is typically to have enough money for retirement. A secondary aim might be to save for specific shorter-term goals like a car, a deposit on a house or a holiday. Unless you are approaching retirement and want to reduce your risk, investing in well-diversified portfolios that combine different asset classes in a single portfolio is a good option. You can construct a ‘basket’ of investments using different unit trusts, or you can opt for a onestop shop or a ‘high growth global balanced’ unit trust. If investing in index-tracking funds, the theory is the same: invest in products that track broad, well-known market indices, such as the FTSE/JSE All Share Index, FTSE/JSE Top 40 Index or the FTSE/ JSE Capped SWIX Index. There are other equity market indices, but those are trickier options for the first-time investor. On the bonds side, invest in a product tracking the JSE All Bond Index; on the property side, the FTSE/ JSE Listed Property Index; and on the international side, the MSCI World Index. The percentages you allocate to each should be dictated by your goals and your risk profile. The more you allocate to equities, both domestic and international, the higher the risk. But remember that if you want to generate high returns over the long term you should have most of your assets invested in equities. Once again there are one-stop shops like the Sygnia Skeleton Balanced unit trusts that do the allocations to different asset class index trackers for you. Make sure you allocate between 25% and 30% of your money to international investments. These offer you dual diversification: diversification away from the rand, and exposure to developed markets and sectors that behave differently to emerging markets like South Africa.
On the topic of index tracking, a crucial decision you need to make is whether you invest via a unit trust or an exchange-traded fund (ETF) listed on the JSE. For the average investor, I recommend a unit trust. If you trade actively in shares, consider an ETF a core investment that offers you exposure to ‘the market’ at a low cost.
The final note is on fees. In investing, expensive does not necessarily equal quality. Always aim to minimise costs as they eat away at your investments. So save where you can, shop around for cheaper alternatives and do your own comparisons, even when using a financial advisor. The National Treasury puts it best: if you can reduce your fees from 2.5% per annum to 0.5% per annum over a 40-year savings time horizon, you will retire with a 60% greater benefit. In investments, you get what you don’t pay for!