The rise of new technologies and fintech has made investing simpler, more transparent and cheaper than before, leading many people to adopt a do-it-yourself approach to their finances. So, in a world where investing is as easy as ordering take-away, what are the dangers of self-managing your investments, and why should you consider seeking professional financial advice?
Asset allocation. Many people focus exclusively on starting costs as the measure of a good investment solution, which is a poor approach to making investment decisions. Instead, once you have started to grow your savings and have a reasonable build-up of funds, discussions around asset allocation become absolutely critical.
As global investment citizens, South Africans enjoy far greater flexibility and fewer offshore investment restrictions than before. Whether you had invested in a low-cost exchange traded fund that tracked the JSE Top 40 for the past five years or a managed unit trust or share portfolio, both of which have higher costs, the results would have been similar and, sadly, almost equally poor. You could have performed better elsewhere.
A good financial adviser may have recommended that you use your offshore allowance to invest in the US markets, despite the fact that the investment costs may have been slightly higher. In this case, you could have earned compounded double-figure returns in dollars over the five years, while benefiting from currency accumulation owing to a weaker rand/dollar exchange rate.
But the point here isn’t to be clever with hindsight. The answer would have been to have invested both locally and offshore, with different weightings at different times. Investing only in the JSE or global equities amounts to backing only one outcome. In a world where the future will surprise, and it invariably does, you need to cater for a range of possible outcomes in your investment strategy. Costs are a secondary consideration.
Diversification. I often hear people comment that they believe they are well diversified because they hold investments with a number of different asset managers - no names, no pack drill.
However, true diversification is about your underlying investments and asset allocation, not the allocation to institutions. In many cases, all people do by investing across different brands is to add a layer of costs while the institutions themselves invest in similar underlying assets. This ironically increases their levels of concentration instead of their diversification, with added costs.
Managing investment risk. A good financial adviser will be able to help you to manage your investment risk in order to generate consistent compounded returns, no matter the prevailing investment environment. Through understanding the correlation between different asset classes and by adopting a highly active rather than a static investment, approach, true risk mitigation can be achieved.
It is the adviser’s or your own DIY job to control your asset allocation, or the combination of funds you hold. Unless this is changing, your asset allocation will remain largely static.
Remember, too, that there is a second race, and that is the relative race between fund managers. In other words, if a balanced fund sheds 10 percent over a year, and its benchmark sheds 12 percent, the portfolio manager will still have cause to celebrate, because they will probably be ahead of their peers, which is often a more important deliverable.
Weathering your emotions. Greed and fear are the two extremes that threaten all investment behaviour, and the danger of doing it yourself is to allow these emotions to cloud your judgment. This is perhaps most evident when people invest their money in volatile assets, such as equities or currencies for short-term goals, placing their capital at the mercy of unpredictable market movements.
However, to make money and grow your investments above inflation over time, you need to embrace volatility, and have enough time on your side to ride this volatility out.
In other words, volatility is the enemy in the short term and inflation is the enemy in the long term, and you need to compartmentalise your investments accordingly. This means that you need to invest the funds that you will need to access within a year or two in a very specific way, and the funds that you will only need in 10 years in a completely different way.
Crunching the numbers on decisions. With the looming threat of a global recession on the horizon, deciding whether to sell out of certain assets and how to best position your portfolio can be very difficult. There is capital gains tax to consider in doing any switch, and, of course, the fear of missing out, or trying to squeeze the last little bit out of the market. Sometimes greed and the fear of missing out work together.
In this case, an adviser would be able to help you calculate the tax implications of selling out of certain assets, and offer objective advice on whether it is worth taking the pain to reposition your portfolio against a market fall.
Then there’s the issue that people are often vulnerable to making investment decisions based on the latest trends, or the grandiose promises made by advertisements, without reading the fine print, considering whether it is aligned with their long-term investment strategy, or realising that their money may be locked in for a long time, taking away any flexibility.
Nic Horn is a director and Durban regional head, Citadel
PERSONAL FINANCE