/ 1 July 2010

How to select the right investment

Peru wants to invest R1 000 for 120 months with an annual escalation.

Maya replies: You are looking at an investment for 10 years, which would be a long-term investment. The risk of investing in equities (stock market) would be lowered by the fact that you are investing monthly so you do not need to worry about market timing. Based on this, an equity investment would make sense.

Investment analysts are saying at the moment that you can expect an average return of about 10% from the stock market — but this could be higher if the economic recovery continues.

So if you investment R1 000 a month for 10 years (I am leaving out the escalation because you did not stipulate the amount), you would expect to have about R200 000 at the end of the period.

The million-dollar question is: What investment product is going to give you the best return over 10 years? That is a question for a crystal, ball but there are some basic points:

  • Passive investments: Exchange-traded funds (ETF) offer a low-cost alternative to investing in equities as these are not actively managed and simply track an index. Check out www.etfsa.co.za.
  • Passive with a value bias: Satrix RAFI is an ETF that tracks some of the large blue-chip shares on the JSE but has a value bias when it comes the weighting of the shares in the portfolio. Back-testing has shown that it outperforms the JSE All Share Index by 4% a year on average.
  • Active management: The drawback of passive investing is that you will not be exposed to smaller shares that could give you an added boost to your returns. (See article on the performance of small-cap shares). In addition, an active fund manager can take advantage of cyclical movements that may favour different companies at different times. A good fund manager would also add value by selecting shares that he or she believes will outperform.
  • Stick with pedigree: The problem is that few fund managers actually manage to outperform the JSE. The key is to select fund managers that have consistently outperformed the JSE All Share Index. Nick Brummer of Investonline talks about “premium brands” such as Investec, Coronation, Nedbank and Allan Gray. If you select a fund manager with a proven track record, over 10 years you are more likely to see superior returns, even if they underperform in the short-term. (see related article in ETF vs unit trusts).
  • Stick with your decision: Over a 10-year period even the best fund manager will underperform at some stage, even for a period of two or three years. However, over the total period the fund will deliver on returns. Do not make the mistake of selling out of an underperforming fund and switching to the current flavour of the month. Research shows that after a period of underperformance a fund manager usually recovers well and delivers above market returns, while the fund that has outperformed strongly has a breather and may underperform. By switching you would miss out on the recovery while buying into the peak of the other fund. If you do your manager selection well, trust your research and stick with it.

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