The rise of new technologies and fintech has made investing simpler, more transparent and cheaper than ever before, leading many to adopt a DIY-approach to their finances. So, in a world where investing is as easy as ordering take-out, what are the dangers of self-managing your investments, and why should you consider seeking professional financial advice?
Citadel Director and Durban Regional Head Nic Horn notes that there are essentially five key reasons to think carefully before adopting a DIY approach to your investments:
1. Asset allocation
Many people focus exclusively on starting costs as the measure of a good investment solution, which is a very poor approach to making investment decisions. Rather, 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 currently enjoy far greater flexibility and fewer offshore investment restrictions than ever before. Whether you had invested in a low-cost ETF that tracked the Johannesburg Stock Exchange (JSE) Top 40 for the past five years or a managed unit trust or share portfolio which both carry higher costs, the results would have been very similar and, sadly, almost equally poor. You could have performed better elsewhere.
A good financial advisor may have recommended that you make use of your offshore allowance to invest in the US markets, despite the fact that the investment costs may have been slightly higher. And in this instance, you could have earned compounded double-figure returns in dollars over the five-year period, while also benefitting from currency accumulation owing to a weaker rand/dollar exchange.
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 in just the JSE or just 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.
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 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.
In this case, a financial advisor would be able to guide you towards achieving true diversification by investing across different asset classes, sectors and regions. In fact, if you cannot pull up your overall portfolio instantly and know what the asset allocation is, then considered diversification is not a part of your strategy. It’s accidental.
3. Managing investment risk
A good financial advisor 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.
For example, as we enter a risk-off environment, our advisors are guiding their clients to add defensive elements or shock-absorbers to their portfolios in case equity markets decline, increasing investors’ exposure to bonds or hedge funds.
This stands in contrast to simply investing in, say, a balanced fund with exposure to different asset classes, given that a balanced fund’s mandate is to beat a benchmark or index rather than to safeguard each client’s wealth. This is not a criticism aimed at the fund manager – that is simply and absolutely their brief. It is the advisor’s or your own DIY job to control your asset allocation or which 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% over the course of a year, and its benchmark sheds 12%, the portfolio manager would still have cause to celebrate, additionally because they will probably be ahead of their peers, which is often a more important deliverable. Again, an advisor’s job is to help you put a plus sign in front of your returns and generate wealth no matter which direction the market is moving in.
4. 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 judgement. 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 do need to be able 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 ten years in a completely different way.
An advisor’s role is to guide you on the appropriate investments for both long-term and short-term goals, and stand between you and your emotions, preventing you from making any hasty investment decisions based on short-term considerations.
5. 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 advisor 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 fund 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 period of time, taking away any flexibility.
A professional financial advisor would be able to help you objectively assess the benefits and risks of any new investments, and assess whether they are truly appropriate to your individual needs.
Nic Horn, Director and Durban Regional Head, Citadel