You need to grow your cap­i­tal and earn an in­come

You need to in­vest in eq­ui­ties if you want your cap­i­tal to grow over the long term. How­ever, you should also di­ver­sify into other as­set classes to pro­vide a cush­ion against the highly volatile na­ture of eq­uity in­vest­ments, Ja­son Gar­ner says. Gar­ner, who m

Weekend Argus (Saturday Edition) - - PERSONALFINANCE - JA­SON GAR­NER

You should not choose in­vest­ments aimed at de­liv­er­ing cap­i­tal growth over those that pro­vide an in­come, be­cause it is bet­ter to have in­vest­ments in your port­fo­lio that do a bit of both, Ja­son Gar­ner says.

In­vest­ing in eq­ui­ties that aim to grow your cap­i­tal when share prices move higher may give you a bet­ter re­turn over the long term than in­come- pro­duc­ing in­vest­ments, such as cash, Gar­ner says.

For ex­am­ple, R1 mil­lion in­vested in the shares that make up the FTSE/ JSE All Share In­dex (Alsi) in Oc­to­ber 2003 was worth R6.57 mil­lion on June 1 this year – more than six times what you in­vested. Al­though about 30 per­cent of this re­turn was a re­sult of the in­come, in the form of div­i­dends, that eq­ui­ties pay, most of the re­turn came from cap­i­tal growth, Gar­ner says.

How­ever, an in­vest­ment in eq­ui­ties is likely to be volatile, with the mar­ket ris­ing and fall­ing over the pe­riod for which you are in­vested. De­pend­ing on when you dis­in­vest, this could re­sult in your suf­fer­ing a cap­i­tal loss, he says.

If you had in­vested the R1 mil­lion in Oc­to­ber 2003 and dis­in­vested in 2008, you could have lost 40 per­cent of your cap­i­tal value.

Over longer pe­ri­ods, in­vest­ments that are in­tended to de­liver cap­i­tal growth typ­i­cally do show gains, but it can be a rough ride, he says.

In­vest­ments in cash, which de­liver re­turns by earn­ing in­ter­est in­come, will give you a smoother ride but a lower long-term re­turn, Gar­ner says. One mil­lion rand in­vested in cash in Oc­to­ber 2003 was worth R2.06 mil­lion in June this year, he says. This is roughly dou­ble what you started with over 10 years ago. How­ever, af­ter tax, this in­vest­ment may not beat in­fla­tion.

Tak­ing the risk of in­vest­ing in a more volatile in­vest­ment def­i­nitely gives you a bet­ter re­turn, Gar­ner says. This is a risk you need to take if you want your re­tire­ment cap­i­tal to last through­out your re­tire­ment, be­cause the num­ber of years that peo­ple spend in re­tire­ment is, on av­er­age, in­creas­ing (see “Pre­pare for a longer re­tire­ment”, right).

Rather than ex­pos­ing your­self en­tirely to the risks of the eq­uity mar­ket, you should make use of the ben­e­fits of as­set al­lo­ca­tion: in­vest across as­set classes so that you are ex­posed to eq­ui­ties that pro­duce long-term growth, but your risk is re­duced by the diver­sity of the as­set classes to which you are ex­posed. In this way, you can en­sure that you get higher re­turns, but at a much lower risk than if you in­vested only in as­sets aimed at de­liv­er­ing cap­i­tal growth, Gar­ner says.

Over the 10-plus years from Oc­to­ber 2003 to June 2013, if you had in­vested in the shares rep­re­sented by the Alsi, your port­fo­lio would have shown the big­gest losses in 2008/9, when your cap­i­tal would have been down 42 per­cent on what you had in­vested, Gar­ner says.

Had you in­vested in a diver­si­fied port­fo­lio with a do­mes­tic as­set mix of 62.5 per­cent in eq­ui­ties, 10 per­cent in fixed in­come and 7.5 per­cent in listed prop­erty, and with an in­ter­na­tional as­set mix of 12.5 per­cent in eq­ui­ties, 2.5 per­cent in fixed in­come and five per­cent in listed prop­erty, the max­i­mum the port­fo­lio would have been down dur­ing the 10-year pe­riod would have been 24 per­cent in 2008, he says.

And if your do­mes­tic as­set mix had been 50 per­cent in eq­ui­ties, 12.5 per­cent in fixed in­come, 10 per­cent in in­fla­tion-linked bonds and 7.5 per­cent in listed prop­erty, and your for­eign as­set mix had been 10 per­cent in eq­ui­ties, five per­cent in fixed in­come and five per­cent in listed prop­erty, the high­est mar­ket fall would have been 15 per­cent.

A diver­si­fied port­fo­lio will nar­row the gap be­tween the high­est and the low­est re­turns over dif­fer­ent pe­ri­ods (see graph, above) with­out de­tract­ing sub­stan­tially from the av­er­age re­turn you would have earned if you had in­vested only in eq­ui­ties over a longer term, par­tic­u­larly if the diver­si­fied port­fo­lio had a higher ex­po­sure to the likes of eq­ui­ties and prop­erty.

Gar­ner says when it comes to risk, you need to un­der­stand that:

◆ You usu­ally want to take as lit­tle risk as pos­si­ble;

◆ Your ca­pac­ity for risk is the risk you can bear to take with­out get­ting cold feet and dis­in­vest­ing, pos­si­bly at the wrong time;

◆ Your risk re­quire­ment is the risk you need to take to meet your goals; and

◆ There are two main types of emo­tional risk:

❑ Greed, which mo­ti­vates you to en­ter the mar­kets when they are at or near their peaks, and there­fore ex­pen­sive; and

❑ Fear, which keeps you out of the mar­kets when they are fall­ing or at their low­est lev­els, and there­fore of­fer­ing good value.

Gar­ner says that a fi­nan­cial plan­ner should help you to iden­tify the risk you need to take and to align it with your ca­pac­ity for risk – the risk with which you are com­fort­able. Then you can choose an as­set al­lo­ca­tion that matches your needs and your ap­petite for risk.

In in­vest­ing, the real en­e­mies are in­fla­tion and, if you are draw­ing from your in­vest­ment, your spend­ing, Gar­ner says.

If your in­vest­ment is not beat­ing in­fla­tion, you are sav­ing your­self poorer, he says.

Your re­quired re­turn has to equal in­fla­tion plus what you are with­draw­ing from your in­vest­ment or spend­ing. If you can­not meet that re­turn con­sis­tently, you need to spend less.

For ex­am­ple, if in re­tire­ment you need to beat in­fla­tion and draw down eight per­cent of your cap­i­tal each year, you will need a re­turn of in­fla­tion plus eight per­cent. At the cur­rent in­fla­tion rate of six per­cent, your re­quired re­turn is 14 per­cent. In this case, in­vest­ing across the as­set classes will def­i­nitely be bet­ter than in­vest­ing only in cash, which is cur­rently de­liv­er­ing a re­turn of five per­cent be­fore tax, Gar­ner says.

How­ever, if you can ex­pect a diver­si­fied port­fo­lio to achieve a re­turn of, for ex­am­ple, 12 per­cent a year, the ad­di­tional two per­cent­age points you re­quire will eat into your cap­i­tal each year, and even­tu­ally your cap­i­tal will be de­pleted – pos­si­bly be­fore the end of your life.

A fi­nan­cial plan­ner can help you to iden­tify this prob­lem and can ad­vise you how to ad­just your spend­ing ac­cord­ingly, Gar­ner says.

In­vest­ing R1 mil­lion in eq­ui­ties, as rep­re­sented by the FTSE/JSE All Share In­dex, would have given you the best re­turns over the past 10 years, but you would have had to ride out big ups and downs in the mar­ket. In­vest­ing in an as­set al­lo­ca­tion port­fo­lio with ex­po­sure to both lo­cal and in­ter­na­tional eq­ui­ties, fixed-in­come as­sets and listed prop­erty can also pro­duce good, al­beit lower, re­turns. The ride would be a lot smoother, how­ever. An in­vest­ment in cash would have out-per­formed in­fla­tion, but pos­si­bly not af­ter tax.

In­vest­ing for longer pe­ri­ods of time re­duces the range of re­turns you will earn from eq­ui­ties. In­vest­ing across as­set classes gives you an even lower range of re­turns with­out com­pro­mis­ing too much on the re­turn over time.

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