Know what type of investor you are before you choose your savings vehicle

2013-08-28 00:00

THERE tend to be two types of investor — those who are very risk adverse, preferring to stick to cash-like investments even for long-term savings, and those who have an appetite for higher risk, higher-return assets.

An investor who is too cautious may find that his or her investment does not keep up with inflation over time, making inflation the biggest risk, while an investor who chases higher returns doesn’t always fully understand that there is a very real chance you will lose your money.

The investor who makes money is the one who understands the relationship between time, risk and return, and understands that different investment strategies need to be applied for different investment goals.

The graph, compiled by Coronation, is an excellent illustration of the relationship between volatility (risk) and growth over time. It compares the performance of three Coronations unit-trust funds with varying risk profiles over a 10-year investment period. It includes the returns from the JSE All Share Index (Alsi), as well as cash for the same period.

Coronation Strategic Income is a low-risk fund that invests in cash-like investments with the aim of marginally outperforming cash over time.

There is no volatility in this fund, meaning the unit price rises steadily over time with no surprises either on the upside or downside. If you invested R100 000 for 10 years, it would have grown to just over R300 000. While that may sound like a lot of money, due to the effects of inflation over time, you would need to have around R250 000 today to buy the same goods and services as R100 000 bought you in 2001. So your “real” return is around R50 000.

The Coronation Balanced Plus is a medium-risk fund that meets prudential guidelines for retirement savings. This means it can be used for a retirement annuity and it invests in a range of assets including cash, bonds, property and equities. As you can see from the graph, there is some volatility.

Investors who could live with the volatility and did not cash in their fund when the market fell, would have received a total return of around R500 000 over the 10 years, more than 50% higher than investing in the Strategic Income Fund.

In fact, during any period after the first five years, an investor in the Balanced Plus Fund received higher returns than an investor in the Strategic Income Fund. That is why it is always recommended, if you have an investment horizon of more than five years, to consider a fund that invests in higher-risk growth assets.

For an investor with a shorter time frame the results are different. During the first four years, the Balanced Plus Fund underperformed the Strategic Income fund. The fund also fell 20% during the financial crisis, while an investor in Strategic Income would have seen a steady rise. A short-term investor would have realised a loss in this time. However, if the investor stayed invested in the Balanced Plus fund, their investment would have recovered by August 2009.

What is interesting is that the Balanced Plus Fund delivered the same return over the period as the average performance of the JSE Alsi, although with slightly less volatility. It did not reach the same peak as the JSE Alsi in 2008, but nor did it fall as much in 2009. This is due to its diversification into other asset classes such as bonds, property and cash.

The Coronation Top 20 is a high-risk fund as it invests only in shares on the JSE and limits its choice to the fund manager’s top 20 stocks.

The volatility is substantially higher than the Balanced Plus Fund. During the crisis, an investor would have seen his or her fund value fall from R503 000 to R355 000 over two years, a 30% “loss”.

But if the investor had not panicked, understood the nature of the fund and held his or her position, he or she would have seen a recovery within five months, and would have received a total return of R750 000 from a R100 000 investment over 10 years. That is R450 000 more than the same investment in the Strategic Income Fund and R250 000 more than the Balanced Plus Fund.

The graph demonstrates the power of the stock market over time, and it highlights its risks over shorter periods.

If you are investing for more than five years, you would be giving up on potential returns by being too conservative. However, if you are tempted to invest in the highest-risk fund, you need to fully understand the meaning of risk.

If you had invested in October 2007 at the very peak of the market, and then watched your life savings collapse by 30%, would you have had the resolve to stick with your original decision, knowing that you had at least five years to recover? If you had, you would have been rewarded, but if you panicked and sold at the bottom of the market, you would have realised your losses and would never be able to recover that money.

For some people, the idea of their savings falling by such proportions may be too much to bear, and in that case it would be wiser to take a more pedestrian approach and select a fund with lower volatility (risk) so you do not risk a knee-jerk reaction that sees you selling at the worst possible time. But be careful of investing in low-risk, cash-like investments for too long as you are giving up too much potential return and face the very real risk that your money will not keep up with inflation, making your poorer.

NOTE FOR GRAPH:

R100 000 invested from June 2001 to September 2011. Coronation returns are net of fund-management costs, but not advisory fees.

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