Vaneshen asks: I have managed to pay off my debts and have about R1 500 that I’m interested in investing.
My big problem is that I’m all confused as to what and how to invest. This is my first time. I don’t know if I should invest in a money market fund, unit trust (Nedbank Rainmaker or Allan Gray Equity) or in an ETF (Satrix 40 or Satrix RAFI). Please help me.
Maya replies: There are so many investment choices out there that starting a savings plan is just a major hassle. I personally believe this plethora of choice is one of the reasons people are not invested correctly. It is just easier to leave the money in a bank account.
You need to have a systematic approach to deciding on the best investment for your needs:
1. What is your investment horizon? Less than two years: Save in cash based investments like a fixed deposit or money market unit trust. This is because in the shorter-term the stock market can be volatile and you may lose money.
2 – 3 years: Consider unit trust income funds or low risk prudential funds that have some market exposure.
More than 3 years: Here your biggest risk is inflation. At the current inflation rate every ten years your money halves in value. You have to invest in a growth asset that beats inflation over time — this means shares (equities) and property.
2. What is your personal risk tolerance?
Based on your age I am going to assume that you want exposure to growth assets. Here you need to decide whether or not you are prepared to ride the volatility of the market.
Over the short-term shares can fall in value. If you are seriously worried by the thought of opening your investment statement and seeing your savings halved by a stock market crash, select a multi-asset class fund like a balanced fund, flexible fund or an absolute fund with a CPI+5% benchmark. These funds allow the fund manager to move between equities (shares), property, cash and bonds and limit the losses from market volatility.
That said, because you are investing monthly, you will be less affected by market volatility and could tolerate more market risk because of “rand cost averaging”. With a regular monthly investment when the market falls you are able to buy more units or shares with the same amount of money because they have become cheaper. So in fact market corrections play in your favour. Although your lump sum value may be lower than last month, you are buying more shares at a lower price which will benefit when the market recovers.
3. Choosing the investment vehicle
As you have highlighted in your question you have a choice between unit trusts and exchange traded funds (ETFs). The main difference is that unit trusts are actively managed and ETFs just follow an index of shares. (Read the related article on the ETF vs Unit trust debate). As many fund managers underperform their benchmarks (the JSE All Share Index) there is a strong argument for just investing in index tracking fund like the Satrix Rafi. These are low cost and guarantee that at least you will get the average market performance.
However there are two reasons to select a unit trust:
– A depending on the mandate a unit trust can give you exposure to other asset classes like property, cash and bonds as well as offshore exposure
– A good fund manager with a proven track record can outperform the index after costs
4. Choosing a fund manager:
Select fund managers with strong track records. That means a fund that remains in the top quartile of its sector over a longer period of time. This fund does not have to be the best performer but must consistently beat its benchmark – otherwise you may as well invest in the benchmark (usually the JSE All Share Index). The fund management houses that independent financial advisors prefer include Coronation, Allan Gray, Investec, Nedbank Rainmaker and Prudential.
5. Costs:
Research shows that fees have more impact on your final return than fund management outperformance! So you need to look at the total cost ratio (TER) of the investment. Keep in mind that this does not include any broker fees if you are employing the services of an advisor.
A fund that has high upfront fees and high annual fees will erode your growth over time.
Performance fees are also something you need to consider. If a fund manager only gets paid if they outperform (Allan Gray for example earns no fees if they underperform) this aligns the interests of the fund manager with the investor. However when the fund is performing well the TER can be very high, as has been the case with Allan Gray recently.
6. Switching hurts performance.
Numerous studies have shown that the average investor underperforms the fund he or she is invested in simply because they move in and out of the fund in an attempt to time the market. Once you have made a decision, stick with it (unless something dramatic has happened to the fund management) and remember that this is a long-term investment.
Attempts to time the market by withdrawing your money when you get nervous will only hurt your long-term performance.
7. Ignore short-term performance
Even if you managed to select the best performing fund, it will at times underperform, so don’t focus on short-term relative performance. Even if you invest in a fund with average performance, you will see your money growing far more than sticking it under the mattress.
Given all of the above, you probably just want me to give a simple solution. I can only give you my personal view (as I am not a registered financial advisor). Personally I invest in an ETF and have a separate offshore investment. However, considering that we are still in very difficult times, a fund manager who is able to make some good calls on shares and when to move into cash or increase offshore exposure could add real value.
Fund managers like Allan Gray, Prudential and Nedbank Rainmaker (which is run by RE:CM) have proven to outperform in bear markets. Perhaps you should consider investing a portion in an ETF and the rest in a fund manager that will give you some protection in difficult times.
But no matter what investment you finally consider, ultimately your final lump sum will be determined by how much and for how long you invested – so start soon.
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