For generations, one had to frequent the local golf course for the hottest stock picks and investment tips. The internet has forever changed the retail investor landscape and individual investors now have a wealth of information to call upon when making investment decisions. The democratisation of investing has meant savvy investors are able to access investment opportunities that were only accessible to the privileged few, without costing the arm and leg that past generations had to fork out to financial intermediaries.
For less savvy investors, the rise in information means they are adrift in a sea of “clickbait”. On the one side of the spectrum, you have news agencies constantly suggesting a recession is around the corner, couple that with teenagers making millions by selling digital pictures of apes online and peers profiting by getting in early on the latest “get rich quick scheme”. Add assets like cryptocurrencies to the mix and the rise in social media to document all of this means that both investors’ anxiety and expectation have gone through the roof.
For those who do not have the time or expertise to process the information overload and differing opinions and predictions, these three points of guidance, coupled with an engagement with an investment professional, can set their investment journey on the right path:
1. Return expectations
Investors must rein in expectations, which is easier said than done when surrounded by >1 000% gains made from cryptocurrencies and peers profiting from investing in the shares of companies like Tesla ($62.81 per share in April 2017, $1 005.05 per share this month) or JSE star performer in recent months Thungela Resources (R29 per share in June 2021, now at R246 per share). Overnight success stories gain a disproportionate amount of airtime on social media, creating the misperception for many everyday investors that this is the norm. In fact, it is far from it, as the below table shows the annualised returns achieved by investing in the S&P 500 over a 50-year period from 1972 to 2021.
Source 1: Moneychimp, Motley Fool
To illustrate that investments do not go up in a straight line and that an investor’s best chance of success is to remain patient, see the below breakdown of annual returns of the S&P500. Although the average annualised return is roughly 10%, very rarely are returns in individual years close to the average.
Source: Moneychimp, Motley Fool and Brenthurst Wealth
But what does a return of 10% per annum mean for the investor? For an investor to double their money if an average return of 10% is achieved, the capital should remain invested for roughly seven years.
The power of compound interest can be explained by the following example:
Assume R1 million is invested in year 0 in the S&P500. We will assume the investment returns the historic average annualised return of 10%. The investor must wait 7.3 years for the investment to gain R1 million and double to R2 million. However, the power of compound interest is such that the investor must only wait 4.3 years to gain the next R1 million and reach R3 million in total.
2. Withdrawal rate during retirement
Many factors play a role in determining the monthly income you can draw from your investments once retired, a good starting point is the “4% rule” widely used in the investment industry. The “4% rule” states that an investor can draw 4% of their capital per annum – R40 000 per year, or R3 333 per month for every R1 million of capital. This 4% can then be increased annually with inflation to last for a period of 30 years.
Age, health, asset allocation etc. play a role in determining an individual investor’s sustainable withdrawal rate, but as the goal of the article is to provide clarity, the “4% rule” serves as a good anchor for investor expectations.
3. May the odds be in your favour
Cash and bonds are considered conservative investments, which according to history means lower returns and less volatility. Equities are considered risky investments, which means higher returns and more risk. Investing, however, remains a game of chance and it is advisable to tilt the balance of probabilities in your favour.
This can be done by giving your capital sufficient time to grow. The below graph shows how the probability of achieving growth increases as your holding period increases. Starting with a 70% chance for a 1-year holding period, rising to 80% after three years and reaching 95% in year eight.
Source: Macrobond; MSCI World Equity Mid and MSCI Large Cap Total Return in GBP, 1 January 1971-6 Dec 2021
This warns us that simply moving up the risk curve (investing more aggressively) later in your life in the hope to secure a better retirement does not guarantee success. As mentioned in lesson 1, equities do not go up in a straight line and although the potential for better returns exists, the balance of probabilities isn’t in your favour if your investment time horizon isn’t sufficient.
Nick Maggiulli puts it eloquently: “your gains are uncertain; your liabilities are guaranteed. If you need to spend money and you can’t, that’s risk. By this definition, investing what you can’t afford to lose might be the riskiest investment choice of all”.
There are many issues to consider when embarking on or updating an investment strategy. To make sense of the most appropriate approach for your personal circumstances, it is advisable to consult an experienced, qualified advisor.
