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Monthly Archives: January 2018

How to Invest the Long Run

Being an optimist myself, I don’t particularly like busting other people’s bubbles — we’ve had enough of those lately. Nonetheless, for my inaugural Long Run column, I have to begin on a negative note: Investing isn’t going to be easy the next few years.”For the long haul, we’re going to be in for a period of fairly tough markets,” says Ralph Wanger, manager of the ( ACRNX) Liberty Acorn fund since 1970. “You’re going to have to have substantial skill to prevail, because you can’t wait for the markets to bail you out.”If you’re still reading — indeed, if you’re still checking out TheStreet.com and other financial news publications — then the bear market hasn’t scared you away. That’s wise, because stocks remain investors’ best bet for the long haul. However, we are in a new era, only not the one people were touting a few years ago.From August 1982 to March 2000 — the greatest bull market in history — real returns averaged 15.6% a year, according to Jeremy Siegel in his book Stocks for the Long Run . That’s more than double the historical rate of equity returns. Regression to the mean hasn’t been fun.This doesn’t mean that you can’t make money. It simply means that the rules of the game have changed — and some tried-and-true rules have returned with a vengeance. Investors who adapt to the changes will fare better than those who are still using the old playbook. The Long Run aims to help long-term investors succeed in this new era, whether the market goes up, down or sideways.In the coming weeks we’ll discuss some smart investing ideas for the long run. But this week, let’s start out by revisiting the Rules of the Game.

Know Thyself

There are plenty of investing strategies out there — buy and hold, deep value, active trading, index investing. The first real step investors should take is determining exactly what type of investor he is.”For a long-term investor, you have to know yourself,” says Michael Mach, manager of ( EHSTX) Eaton Vance Large-Cap Value . “The key is to pair your personality with a logical investing approach. If you apply it consistently, you’ll prove successful.”If you don’t mind taking on a heaping portion of risk — and don’t lose your cool during periods of extreme volatility — you can probably embrace a more risky strategy. Since most investors fall into the uncool camp (myself included), the Long Run will often focus on strategies that avoid undue risk and market-timing, favoring fundamental analysis and longer time horizons.Also, you have to be honest with yourself about how much time you will devote to tracking your investments. It’s best not to take big stakes in a few companies in the rapidly evolving biotechnology industry, for example, if you don’t plan to keep up with sector developments.

Diversify

Diversification is probably the simplest truth in all of investing — and the most often misconstrued. In the 1990s, asset allocation for a lot of people meant 100% stocks, and about 90% of those stocks were large-cap growth.Virtually all investment vehicles have their ups and downs. However, too many individual portfolios consist of holdings that all move up at the same time and back down at the same time.”Investors need diversification, and by that I mean they need to diversify away from large-cap domestic equities,” says Louis Stanasolovich, founder and chief executive of Legend Financial Advisors in Pittsburgh. “Buying three Fidelity funds, two Janus funds, American Funds Growth Fund of America and an S&P 500 index fund is not diversification.”To achieve real diversification, investors need to build portfolios using investments with lower correlations to one another. For example, for your equity holdings, consider paring back your large-cap weighting and boosting exposure to emerging markets, international stocks, smaller-cap stocks and real estate investment trusts. (Using quantitative models, Stanasolovich has designed a well-diversified, “lower volatility portfolio” that returned 22.3% in 2000, a negative 2.2% in 2001 and negative 4.25% in 2002. In a forthcoming Long Run we’ll discuss diversification with him at greater length.)

Reinventing Do-It-Yourself Investing

One of the supposed hallmarks of the bull run of the 1990s was the rise of the do-it-yourself investor. The collapse of the stock-market bubble has led some pundits to declare the do-it-yourself movement dead.This is rich irony. One of the primary reasons why investors got so over their heads the past few years is that the notion of “do-it-yourself investing” was cast aside — or at least poorly redefined. D-I-Y investing doesn’t merely mean watching business news, reading The Wall Street Journal or TheStreet.com, listening to analysts or inside tips from your brokers; it means pulling up your shirtsleeves and doing your own additional research before making decisions. Doing it yourself isn’t buying the stock that a professional or CEO just mentioned on CNBC.To redefine do-it-yourself investing, I’ll defer to the original meaning of the phrase, succinctly put by Peter Lynch in One Up on Wall Street way back in 1989. “Stop listening to professionals! … Ignore the hot tips, the recommendations of brokerage houses and the latest ‘can’t miss’ suggestion from your favorite newsletter — in favor of your own research.”This isn’t to suggest that you disavow all mutual fund managers, stock analysts, business news pundits and all other professionals. There are plenty of intelligent and trustworthy folks who can help you be a better investor — and in the Internet age, you have plenty at your disposal. It simply means “trust, but verify.” Use these resources to supplement your research, not replace it.

Be Passionate About Investing, Not Your Investments

Being a successful do-it-yourself investor involves a lot of fundamental analysis, poring over company statements, analyst reports and online and offline research. You have to be passionate about it. You shouldn’t, however, be overly passionate about the investments you make.”You have to be unemotional about the investments you hold,” says Eaton Vance’s Mach, who studied psychology at the University of Chicago and was a family therapist before managing money. “You don’t want to be driven by emotions like fear and greed.”This always holds true. But it becomes especially important to remember in a topsy-turvy market marked by lots of sudden moves but no sustainable upward trend. Investors need to stick to their guns and not blindly follow.”A lot of people wanted to sell everything in September 2002 because they thought the world was ending, then in October they wanted to buy everything because we were going to the moon again,” Wanger says. “Turns out, neither one was such a good idea.”

The New Era

To get a sense of what the new era might look like, let’s take a quick look past the market peak of 2000 to two previous stock market peaks: 1929 and 1966. Stocks didn’t return to their previous heights until 1954 and 1982, respectively. When you adjust for inflation, make that 1955 and 1994, Wanger says.I’m not sure if it will take a quarter century to get back to March 2000 levels. But I do think investors need to realize that getting rich quick in this market isn’t a recipe for success. I am also fairly confident that overweighting the previous decade’s leaders — technology — isn’t such a hot idea either. The 35-year chart below shows what happened to the energy sector after the energy bubble burst in 1980, and how technology has performed before and after its bubble.

5 Ways to Trim Your Investing Taxes

1. Tax reporting methodology

Tax-reporting methodology refers to how your capital gains from asset sales are reported for tax purposes. There are 12 methodologies; which one your financial services company uses will directly affect the amount of taxes you will owe. Many custodians use the “average cost” or “first in first out” (FIFO) methodologies. But there are other options, such as “high cost long term” (HCLT), that can help you save on taxes.

For example, let’s say you bought five shares of stock at $20 a share. Later you bought five more at $25 a share and then five more at $30. Two years later, the share price goes to $47, and you need to sell three shares to rebalance your portfolio.

You would have the following capital gains using the given tax reporting methodology:

  • Average cost: $22 gain per share. (Your gain is based on the average price of all the shares you bought, which was $25.)
  • FIFO: $27 gain per share (The first shares purchased — for $20 — are the first ones sold.)
  • HCLT: $17 gain per share (The most expensive shares held for more than a year — those you bought for $30 — are sold first.)

Clearly, the HCLT method would result in the lowest taxable gain. Your taxes would be highest with the FIFO method.

Not all custodians make more tax-efficient options available, so be sure to check how your financial services company reports your gains.

2. Tax-loss harvesting

Selling securities at a loss to offset capital gains on other securities is referred to as tax-loss harvesting. Investors often use harvesting to limit the recognition of short-term capital gains, which are taxed at higher rates than long-term capital gains (at least on the federal level). This applies only to taxable accounts, not to tax-deferred accounts such as 401(k), IRA or Roth accounts.

Here’s an example. You have a diverse portfolio of U.S., international and emerging-markets mutual funds. With the recent decline in emerging markets and the stronger U.S. gains from last year, you find your portfolio’s asset allocation is off target. You need to sell some U.S. holdings, which will trigger some gains. At the same time, though, you can sell your emerging-markets funds at a loss to offset the gains. You then buy a different emerging-markets fund in the amount you need to get back in balance. (Check with your custodian to be sure you will not be violating the 30-day wash sale rule.)

3. Asset location

As people build assets for the future, most have a mix of equities (stock) and fixed income holdings (cash and bonds). Many people have a tax-deferred account such as an IRA, 401(k), or 403(b). Some have tax-free Roth accounts, and many have taxable accounts. Where you hold assets among these three types of accounts can make a big difference in your tax burden, particularly if you are in a higher tax bracket.

It is most tax-efficient to have the assets with the greatest growth potential in Roth accounts, so you never pay income tax on all the growth. The next-best option is taxable accounts, so you can take advantage of lower long-term capital gains tax rates rather than the ordinary income taxes you would pay on distributions from a tax-deferred retirement account. Fixed income assets should be in tax-deferred accounts, so that the investment income you are saving for the future isn’t taxed on top of your earned income.

Another reason to keep equities in taxable accounts: Upon death, there is a “step up” in tax basis that can save your spouse or heirs a substantial amount on their tax bill.

Unfortunately, many folks do not even know their target asset allocation, and of those that do, many will have that same allocation in all of their accounts. This can result in a greater taxes bill than if they had strategically located different asset types in the most tax-efficient accounts.

4. Passive vs. active funds

Some equity funds see very little turnover of the securities in the fund over the course of a year. Actively managed funds buy and sell with greater frequency. The added trading often results in capital gains; those gains are reinvested, but you still get a tax bill for them at the end of the year.

For instance, the Fidelity Spartan 500 Index Fund (FUSVX) has a 4% turnover rate per year and since October 2014 has generated only 43 cents of long-term capital gains per share. Meanwhile, the Fidelity Disciplined Equity Fund (FDEQX) has a 191% turnover rate and in the same time period generated $1.16 per share in long-term capital gains and $1.33 in short-term capital gains, which are taxed as ordinary income. Ouch! Avoid actively managed funds in your taxable accounts!

5. Exchange-traded funds vs. mutual funds

Exchange-traded funds (ETFs) are more tax-efficient than mutual funds when held in taxable accounts because of a difference in accounting. When a mutual fund investor sells his or her shares, the fund company must sell securities to generate the cash to fund the redemption. This creates capital gains in the fund for the other shareholders.

However, when an ETF investor wants to sell, the fund company simply sells the shares to another investor like a stock, and thus there is no capital gains transaction for the ETF. (This difference does not apply for a tax-deferred retirement account.)

Advice for a young investor

I am truly sorry to hear of the loss of your father. Taking responsibility for the family’s finances at 22 is no small task. I trust that over time, the pressure of managing your family’s financial matters and completing your studies holds you in good stead in the future.

As you embark on this new journey in the investment world, I want to stress the importance of staying anchored in your financial goals and the investment strategy you choose to use in order to achieve them. If you do not believe in your investment philosophy, your prospects for success diminish and you are at the mercy of emotion.

You should also remain mindful of the following principles: risk and return are related, diversification is the antidote to uncertainty, asset allocation determines the rate of return in a diversified portfolio, and emotion undermines the best investment strategy.

I will address your question pertaining to your investment strategy but I am unable to offer further guidance as I have limited information as to the capital invested as well as your monthly income needs and future goals. You will also need to talk to a professional with regards to the potential tax implications of your decisions.

The main purpose of the MSCI World Index ETF is to track the MSCI World Index. The fund follows a buy and hold strategy, commonly known as passive investing, which results in lower management costs compared to most actively managed funds.

Tracker funds typically offer long term capital growth. If you want to achieve maximum capital growth over the long term, however, re-investing dividends is essential in order to maximise the compounding effect.

That said, there are a number of reasons why I agree on the approach you have described as the launch pad for your investments:

  • By choosing to invest directly offshore via tax clearance, you avoid annual asset swap fees charged when investing in South African-registered foreign investments.
  • At a later stage, being invested directly offshore will give you access to a much wider range of investment options, should you wish to diversify your portfolio.
  • Another advantage of being directly invested offshore is that you will be disinclined to cash in your investment should the need arise.
  • Your choice of an ETF is both simple and very cost-effective. Vanguard in particular is considered to be the leader of index tracking investment options worldwide.
  • You automatically achieve a very wide level of diversification within the asset class you have chosen, which in this case is global equities. The ETF you have selected contains over 1 700 underlying shares spread across the globe.

However, given that you mention that you wish to use the dividends for monthly expenses, you do need to consider that

  • The investment you have chosen is not designed to maximise dividends. If income is therefore your primary goal, this may not be the most effective way of achieving that.
  • The Vanguard MSCI World ETF also does not pay out dividends every month. Distributions are only made quarterly. On top of this it is administratively clumsy and expensive to repatriate dividends every few months to South Africa.
  • Withdrawing dividends is also potentially in conflict with the long term nature of the investment. The reinvestment and compounding effect of the dividends within the investment are important factors in achieving a healthy positive real return over time.
  • Index investments can never take advantage of specific opportunities that present themselves. The return of the investment will always be similar to the index.
  • While the employment of an index-based investment may form part of an overall investment strategy, it should not comprise the sum total of your strategy. Once your portfolio has achieved a certain level of growth, you should diversify into various growth asset classes and sub-classes such as equities in emerging markets, property, bonds and possibly even hedge funds. Within such a strategy, you should employ both passive (index) strategies as well as active strategies in order to achieve maximum returns.

Young investors should read this

 Equity investing

The problem you have mentioned is that you have had difficulty finding the time to manage your portfolio. First you need to make the distinction between speculating and investing. If you aren’t taking part in speculative trading, you don’t need to be sitting in front of your laptop watching the markets all day.

The time required for investing is in the form of research prior to making an investment. This doesn’t mean you need to monitor your portfolio constantly but rather make good decisions at the outset and practice restraint when you are tempted to react to short term market volatility.

This is where it may be in your interest to appoint a manager with the necessary expertise, who will build and run a bespoke portfolio for you. You want to find one that will allow you to be involved in the stock picking, but also provide guidance.

You have stated that you have learnt a lot so far through trial and error and would like to learn more in future. This would be a great way for you to continue learning, rather than pulling out of your share portfolio completely.

While there would be a fee involved (usually around 1.5{fca2e095024080cfdb77550ebe9d0b9b9b8f127e3d2d431587c2923167dcc9e7} per annum), the manager would hopefully provide a service that would be worth it and may well earn his fee by preventing you from making some costly mistakes. This way you can continue to learn practically, and put in as much or little time as you can afford to.

Whether or not this is a suitable option for you would depend on the value of your share portfolio. If your portfolio is too small at the moment to diversify sufficiently, it would be advisable that you rather go the route of ETFs or unit trusts. This would also apply to the monthly debit order investments that you mentioned. But whichever of these you choose, the same thing applies in terms of prior research and guidance.

One of the benefits of ETFs is that fees are relatively low and you can access a diversified portfolio with only a small investment or monthly debit order rather than a large initial lump sum. You can also choose to have exposure to a particular country, asset, currency or industry.

Your returns will be the average of that sector or type of asset that the fund aims to track, and are unlikely to outperform the market or relevant benchmark. Once again, you need to do some initial research if you are going to start picking ETFs like you pick stocks, and so the time requirement may actually be the same.

You can also consider unit trust funds, which are actively managed by managers who aim to outperform their benchmarks rather than replicate them. There are hundreds from which to choose and each has a different objective, risk profile and asset allocation, so once again, you need to do your research wisely or get some professional guidance.

There is not one solution that suits everyone, and while it is better to be invested than not, making a rushed decision without getting any personalised advice can result in a bad experience that discourages you from investing in future.

Property

The second part of your question relates to property investment, but the same principles apply. It is essential to do your research and calculations, take all the actual and opportunity costs into account, and make sure that what you are buying matches your expectations and requirements.

As far as research is concerned, get to know the property you are considering purchasing. Stick to areas with which you are familiar, speak to different property management companies in that area, arrange for an independent valuation of the property and be willing to walk away at any point and keep searching if it doesn’t seem a good enough opportunity. Rather learn more about what you are looking for by wasting a bit of time in the research phase, than actually buying the property and then realising it wasn’t the right choice.

It is important to set out a plan, taking into account all of the costs associated with purchasing as well as owning the property. These include, but are not necessarily limited to, the transfer duty, conveyancing fees, bond registration costs and initiation fees, rates and taxes, levies, insurance, maintenance, letting agents fees, and estate agent’s fees when selling. Consider the age of the property and potential maintenance that will be needed in future as well.

Work out what you can expect in terms of appreciation in the property price relative to rental income and ensure that the income will meet your needs in order to pay the associated costs. Take into account local vacancy rates which is also something you can speak to a property manager about.

Also consider whether you will appoint a property manager to assist in finding the right tenant and making sure they pay on time. This comes at an extra cost.

In terms of a bond, an access bond would be advisable so that you can register the bond on one property and if you pay it off, you can still use that bond for purchase of your next property. In this way you could save on bond registration costs as you accumulate more properties over time and you are able to leverage off of properties you already own in order to acquire more.

Remember that whether you are investing in shares, ETFs, unit trust funds or property the process is the same. There is no secret formula that will make or break you. It may not be ground breaking advice, but good planning, reliable advice and patience are where your focus should be.

Time for Clear Heads

These difficulties aren’t limited to South Africa either. Global economic growth is still tepid and geopolitical tension is high.

“It’s very much at the top of everyone’s mind that there are very high levels of uncertainty both on the political and macro economic fronts,” says the manager of the PSG Equity Fund, Shaun le Roux. “As far as politics is concerned we have what’s going on inside the ANC, a very divisive US election, and Brexit and its consequences. On the macro economic side, there are big questions around the South African economy, which is going through a very tough patch and may be looking at a recession.”

Of these, the local political landscape is perhaps the most concerning. However Le Roux says that while the stakes are high and the outcomes unpredictable, investors shouldn’t make hasty decisions based on noise alone.

“What one needs to bear in mind is that when a story is dominating all the newspaper headlines the market knows about it and the market tends to be quite efficient at pricing in bad news,” he argues. “In this regard our analysis shows that something like a sovereign debt downgrade is pretty much priced in by the market already.”

Although there could still be a crisis caused by a successful attack on the integrity of treasury and the Reserve Bank, this is not PSG’s base case. Nevertheless it’s important to be diversified to be protected against even the worst possible scenario.

“The main pint that we try to make to clients is that when the world is this uncertain and the range of outcomes is this wide, we think you gain very little by trying to forecast exactly what is going to happen,” Le Roux says. “Brexit is the best example of how futile this can be. What we are rather focusing on is trying to make decisions that give our clients the best chance of achieving their objectives.”

This requires taking a long-term view and seeing opportunities beyond the market noise.

“When there are this much uncertainty and fear, we typically find that the market will give you some good opportunities,” says Le Roux. “But you need to be able to take a long-term view backed up by a long-term process. We are prepared to be patient, but we also can’t dismiss the risks out of hand. We just have to make sure that our clients are adequately protected.”

This means ensuring that they aren’t exposed to assets that could incur permanent capital losses. At the moment, Le Roux believes that there is a very real risk of this in certain assets.

“The anomaly is that even though there is all of this uncertainty and fear, at the same time there is a backstop to global financial markets in the form of ridiculously low developed market bond yields,” Le Roux says. “A consequence of this is that asset classes that are deemed to be related to bonds, specifically the highest quality equities are trading at very elevated valuation levels. We would argue that ownership of inflated assets poses the biggest risk to future performance for investors.”

At the same time, there are other parts of the market where the uncertainty has given rise to attractive asset prices.

“This includes domestically-focused business in South Africa such as banks, where the tough economic conditions and the recent spike in bond yields have had a dramatic impact on share prices,” Le Roux says. “In the last six to nine months we have been buyers of financial stocks and have also been adding South African bonds to our multi-asset portfolios.

“It’s important to note that we hadn’t been invested in South African bonds for a number of years before this,” he adds. “ It’s only in recent times that we think we can buy them at a margin of safety and at levels that lock in attractive real yields on a long-term view.”

Ultimately, he argues that the only safe way to negotiate times like these that are so uncertain is to focus on the fundamentals as much as possible.

what you’ll do after retirement?

 However, more and more people are having to ask what happens next. In a time when life expectancy is steadily increasing, the idea of throwing away your briefcase and putting your feet up to live out your ‘golden years’ in peace and quiet is looking increasingly less appealing, and less practical.

For a start, there is little point in retiring ‘to do nothing’. Many retirees find that they are actually busier than they were during the working lives, but the difference is that they can do what they enjoy.

“We are finding more and more people who are re-thinking retirement,” says Kirsty Scully from CoreWealth Managers. “In most cases, they have been professionals in their careers and they want to stay employed to continue with their personal and professional growth and development, yet they don’t want a typical work schedule. They are looking for flexible working arrangements so as to have a good balance between work and leisure.”

Wouter Dalhouzie from Verso Wealth says that from both a mental and physical well-being point of view, it is important for retirees to keep themselves occupied.

“I had a client whose health started failing shortly after retirement,” he says. “He started a little side-line business and his health immediately improved. When he retired from doing that, his health went downhill and he passed away within a matter of months.”

Verso Wealth’s Allison Harrison adds that she recently attended a presentation that discussed how important it is for people to remain active. “The speaker explained that if we don’t continue using our faculties, we lose them as part of the normal ageing process,” Harrison says. “The expression she used was ‘use it, or lose it’!”

She relates the story of a retiree who had been in construction his entire working life.

“After a year in retirement, he decided to buy a second home, renovate it and sell it,” Harrison says. “This was very successful, so he decided to repeat the exercise using his primary residence.  This yielded a bigger return than the first one and thereafter then moved from house to house, renovating, selling and moving on.”

This way he ended up making more money in his 20 years of retirement then he did in his 40 year building career.

But what about the money

 Encouraging retirees to stay active for the sake of their health may be fairly uncontentious, but the harsher reality is that many people in retirement have to find something to do for more than just the sake of keeping their minds ticking over.

It is accepted that the vast majority of South Africans will not have saved enough to retire comfortably. Many people will therefore need to look for some kind of work to supplement their incomes.

This problem is only going to grow larger as people live longer and their money therefore has to last longer.

“Because of the way medical technology is developing, we now plan for money to last until our clients are 95,” says Hesta van der Westhuizen, an advisory partner at Citadel. “But the way things are going life expectancy could be 120 for anyone being born today.”

Already many people retiring at 60 still have a 30 year time horizon, and that period is only going to grow longer. Van der Westhuizen argues that this means people need to start thinking about starting an entirely new phase in their lives.

“These days a lot of people reach 60 and say they are going to retire now and do another job, but I think we need to start changing our mindset and think about the possibility of going back to university to get another qualification to do the things that we actually always wanted to do,” she says. “We are going to be so much healthier for so much longer, and we need to think about what that means.”

In other words, we may need to consider starting a whole new career post-retirement, and not just finding another job. This has big financial implications.

“If you get to 60 and you say I am going to get another job, some companies might take you on on a half day basis or as a consultant and you might continue earning income immediately, although perhaps at a lower level,” Van der Westhuizen says. “But if you start a new career, you might go to back to university, and you will have to provide for that.

“My opinion is that in the future, we will have the ability and the health to do a second degree and launch another career and that will have exactly the same financial impact as when you started your first one.”

This means that financial planners may also have to start having new kinds of discussions with their clients.