If you are unlikely to make big money selling a business or inheriting funds, don’t think you will never become wealthy. Ordinary salary earners can grow impressive portfolios of assets, provided they understand how to make the most of their income.
Dawn Ridler, an independent financial advisor in Johannesburg, shares some of her observations on what smart investors everywhere in the world have in common. Her main message is that you don’t need to be a mathematical guru to be a successful investor. Very important, though, is to understand yourself – in particular your behaviour when it comes to money.
Before you can invest, you need to free up cash. Ridler highlights how small, but important mental changes can help you transform your limited income into a basket of funds, properties and other assets to ultimately generate an income stream when you no longer receive a regular salary. – Jackie Cameron
By Dawn Ridler
Whether you like it or not, investment success is in the behaviour, not luck. So let’s have a look at what savvy investors do:
1. They know their limitations
Investment is complicated, even experienced brokers will shy away from giving investment advice – or recommend safe, well-known funds. The more you know about investment though, the scarier it becomes, but that is way better than thinking you know everything. There is nothing like being unconsciously confident (thinking you know everything when in fact you don’t).
Unless you’re prepared to spend a considerable portion of your week keeping up with the global trends, tax implications, regulatory changes, economic indicators etc, get a trusted advisor to give you a hand. That advisor can do due diligence on the unit trusts or shares that you buy, investigate the fees on the platforms you use, investigate the investment philosophy of the asset managers you want to use, divert your funds into the right types of investment, make sure your investments are aligned with your objectives and timelines and alert you to macroeconomic changes.
I know that paying your advisor a fee is a grudge, but regulations are changing to make it a win-win. In return for that fee you are entitled to feedback and ongoing monitoring of the appropriateness of that investment. Although a fee might erode the investment, believe me, a park-and-leave approach to investing can be even more dangerous. I continually come across investments that have been in parked for 20 years or more and are not even keeping up with inflation.
2. They know that you can’t buy respect
Keeping up with the Joneses is probably one of the most toxic behavioural traits when it comes to wealth accumulation. Wealth is what is left after you have consumed your income. It is as simple as that. There is no point in seeing yourself as a smart investor if you don’t leave yourself anything to invest with at the end of every month. If you worry what people will think about the car you drive or the house you live in, perhaps you need to spend some time with a shrink or a coach and not on property.com or going for test drives.
3. They get pleasure out of saving, not spending
Buying ‘stuff’ releases endorphins; it is the modern equivalent to hunting and gathering. The molecular structure of an endorphin is similar to morphine or heroin, is it little wonder that the behaviour can become addictive (basically a shopper’s or runner’s high).
Fortunately the brain is a very plastic organ and you can teach it new pathways. I am not saying that it is easy, and cold-turkey in this instance works – but is painful. Whatever method you use to get the endorphin pleasure, get it from the right things and not those things that destroy your wealth.
4. They know the difference between a classic and flavour-of-the- month
Chasing the flavour-of-the-month in anticipation of better returns has another, not so cool, descriptor. It is called greed. We are all driven by either fear or greed to some proportion, and if you want to be a smart investor you need to learn to take a step back from an investment decision and decide which of the two is driving your decision.
If you are making the investment decisions and find yourself making numerous fund switches in the year – is it fear or greed driving these changes? Intraday or currency trading is fast replacing online poker for gamblers.
5. They understand the difference between active and passive investing
Not only do smart investors know the difference between active and passive investing; they know that it is not either/or. Over the last eight years passive ETFs and Trackers have way outperformed most active managers once their low fees have been factored into the equation. Will they still do that as the global economies come off the boil?
Slick investment bankers have been constructing ETFs and Trackers that are so complicated and contrived they can hardly be considered ‘passive’. The last time those creative product construction engineers were given free rein they came up with subprime loan products – and we all know how that ended. If the market comes off sharply, investors’ appetite for trackers will probably wane.
6. They have clearly defined investment objectives
We all have different goals with different time horizons, but smart investors know that different timelines mean different asset allocations and tax implications. Investment is not a one-trick pony; investments need to be sorted according to objective and managed accordingly. An emergency fund needs to be treated very differently to retirement funds or a college fund with 10 years to go.
7. They diversify their types of investment
As I said above, investment is not a one-trick pony. Smart investors have a fully stocked emergency fund, tax free savings accounts, retirement funds (using tax breaks), flexible investments, stock portfolios, rental portfolios and maybe an endowment (if the pros and cons have been properly weighed up). Maximising your tax breaks is smart; that is not just the retirement breaks, but annual CGT and interest allowances. Diversification is not using 7-10 different funds in your investment. This is often the approach of inexperienced brokers or investors wanting to ‘hedge’ their bets. All that happens is you get a market average – with high fees. If you want average, get a tracker or unitised ETF and save 1-3% on those fees.
8. They understand the power of passive income
Smart investors think laterally about their investment, and weigh up the risk versus return. Dividends can be a good source of passive income, so can rental income. Having a rental portfolio can significantly add to your retirement pot, but it is not passive – it is high maintenance compared to other investments and needs to be diversified with five or more properties (which is costly). If you’re an employee and your company is going to put you out to pasture at 60 – what are you going to do for the next 30 or 40 years. More importantly, how much money are you going to need to fund that? Constant learning and skills acquisition is a fact of life.
9. They build their retirement savings from day one
In your 20s and 30s retirement seems so far into the future it is quite understandable that present financial pressures take precedence over retirement. You might feel that there is always time to catch up, and that might be true – but what if it isn’t? It is in those early working years that wealth habits become entrenched but it is never too late to learn. Understand the wealth equation: Wealth is what is left once you have consumed your income – and work on all three components. Always preserve retirement funds when you change jobs.
Given time, investments compound and a small nest-egg can grow massively in 40 years. If you don’t trust yourself not to dip into a pension preserver, put it into a retirement annuity (that cannot be touched until you’re at least 55). Be your own ‘nanny’. Work with an advisor so you know how much you are going to need to fund a 30-40 year retirement and put even more away in your personal RA if the company pension isn’t going to suffice.