Building Wealth takes a great deal of energy and attention to detail.
Wealth measures one's ability to survive if all sources of income are removed. If you were to retire how would you survive?
What monthly income would you need?
How long would you and your spouse live after retirement?These are determinants of how much capital (wealth) is needed to provide an adequate pension.
If you have 10 million invested you may feel that is
adequate to provide a very good pension. If all the
interest earned (assuming 8% pa) is used as a pension and
nothing is reinvested, you would get a pension of 66 667
per month. However, over time, inflation (assume an
average of 8%) would erode this to 8 333 if you are still
needing a pension 30 years later.
In creating wealth, it is also advisable to make provision in case something happens in your family (death, severe illness, disability). The best way to do this is through some form of life insurance to protect your wealth. Beware, the more insurance the salesman sells, the more profit he makes, and the more it costs you. Do not accept cover beyond a reasonable amount.
Recommended reading: The Informed Investor: A
hype-free guide to constructing a sound financial
portfolio by Frank Armstrong III (Amacom).
Before you embark on investing, some thoughts about Money!
It is important that you, as an investor, understand how money works. How else can you make it your servant? I would recommend you study a first year university/college-level Economics text-book (which includes Macro-Economics).
Money has value only because those who use it as a medium of exchange agree that it has the value printed on it. After the barter system, and going back over a hundred years, price was set in ounces (or parts thereof) of gold. To buy anything meant weighing out the right amount of gold dust, or cutting a piece off a lump of gold and weighing it. Then governments produced coins made of gold and silver, and the value of the coin was determined by its weight. This system didn't work, so government started producing paper money, printed with a promise to pay the bearer, on demand, the equivalent amount (value) in gold. Bank notes no longer make this promise. If you went to the central bank and demanded a bank not be exchanged, they would present you with an identical note.
Banks use money creatively (and legitimately) to create wealth for themselves by increasing the money supply:
Increase in the money supply is always inflationary. This explains why the Reserve Bank makes it much more expensive to borrow money and to deter buying on credit from the banking system by pushing up the interest rates.
When the State prints money the effect is also
inflationary. Recently in Zimbabwe there was no money to
pay the military and police, so the solution was to just
print more resulting in uncontrollable inflation at
around 200-million percent per annum and growing.
Those who fail to plan: plan to fail!
You have seen this before.
The sooner one starts investing the easier (and cheaper) it is to attain a target. Sown graphically, as the number of years to retirement decreases, the amount needed to meet a capital amount (illustrated at 3.5million) escalates dramatically.
If you start investing 30 years before retirement you need only invest 1,000 per month (= total of 360,000); if you start with 20 years to go you need to invest 3,500 per month (a total of 840.000). (This ignores the effects of inflation on the value of money.)
What has this got to do with investment and risk?When you are younger your attitude to risk is that you are willing to take greater risk (aggressive investment). This means you are willing to lose some of your investment balanced against the opportunity of much higher returns. If you lose some of your investment you have time to recover and get back on track to your overall goal.
Before investing you need to know what your attitude to risk is this will affect the next page on portfolio building.
To determine your own attitude to risk CLICK HERE to open a risk-assessment questionnaire.
Banks and insurance companies are in business to create
profits for their share-holders. They are not in business
for the financial benefit of their customers
(account-holders or policy-holders). They provide a
service to both these, but their motivation is to do so in
such a way as to perpetuate and increase their profits.
For every service they provide there is a cost attached!
At one level that is fine. They provide a service and I
must expect to pay for that, just as I pay a plumber, a
lawyer, a motor-mechanic. However, at another level, that
is not fine as I, the customer have no space to negotiate
what a reasonable charge is for the service provided, and
often (usually?) the charges are not disclosed up front.
Both banks and insurance companies are highly profitable. It is interesting to reflect on the high degree of cross-shareholding they hold in one another. Insurance companies are very successful at investing their own funds and getting good growth, thereby boosting their profits further. Because of this success insurance companies think they are investment experts, which is not proven when it comes to investing and building client portfolios because the economies of scale are so different.
HOW THE COSTS ARE GATHERED:
be an informed investor & make the right choices
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The way to build a property investment portfolio is slowly, and gently.
Now, having got accustomed to paying 6,607 per month, rent the first house and buy a second house and live in it. The rental on the first house is usually around 1% of the value = 5,000 per month. Your new house of value 800,000 can be repaid in under 10 years.
Now repeat the process your rental income is now 13,000 per month, so you can now afford a house of around 1,5mllion.
Or instead of constantly upgrading, keep to houses around the same value as your first one, and buy 2 or 3 or more at a time.
These calculations leave out the factor that property is generally increasing in value and price all the time (with ups and downs).Your return on investment is measured in the growth in value of your investment holding plus rental incomes received. The risk associated with this is that rental may not be paid (a downturn in the economy may mean people can't afford the rents you require). If you hit this scenario, it would be helpful to have diversified in other investments so you can draw on those to cover the shortfall. Of course you can always sell property you hold, but are unlikely to get a meaningful price in a buyer's market.
Trading on the Stock Exchange for shares or futures or bonds is, potentially perhaps, the most lucrative way of investing money to maximise growth. But, taking risk into account and making sure one is not too exposed to risk is an almost full-time occupation. Building wealth takes lots of hard work and attention to detail - and that is particularly true of the stock market route. The big investment companies have departments who are fully occupied monitoring and managing their investment department's exposure to risk.
By all means, try this as an avenue for your investment,
but always ensure you hold sufficient diversity.
One of the advantages of Unit Trusts / Mutual Funds is
that the holding company has fund managers who evaluate
risk and potential for growth within the whole portfolio
of shares (or other investments) that are held. For this
reason, the remainder of this site looks only at Unit
Trust / Mutual Funds as a recommended vehicle for wealth
creation (not excluding any other asset class). Having
said that, a
word of caution: Because it is important to know
what is going on in your investment, full dsclosure
becomes a major issue. Unit Trust / Mutual Funds do not
always adequately disclose their cost structures, so that
may introduce an additional risk factor. (In the late
1980s I was consulting to a major insurance company in
South Africa, which had built a massive office block in
Sandton, South Africa. This package actually made the
company insolvent, and they were swallowed up by another
insurer which was 20% of their size. The new company got
out of that building very quickly. It is now owned by one
of South Africa's largest investment groups. Makes one
think what costs they are hiding.)
The danger with investing in shares is that you buy at the highest price and sell at a low price a purely emotional reaction to price fluctuations and a certain way to make big losses. Ideally, buy low and sell high that is the skill of a successful investor.
To invest in the stock exchange one typically needs to
appoint an investment / stock-broker (who has a dual
function of buying on your behalf, and of advising you of
perceived good deals.) Some banks provide the service of
buying shares on your behalf. You need to know the costs
involved using a broker or bank, and factor this into your
Having said that the stock market takes a lot of energy and effort, help is at hand. There are competent, effective stock market analysts around, who can do much of the leg work for you. One I recommend in South Africa is Frank Black (a former colleague in a different industry). Look at his web site: Stock Market Performer or contact him via email:
Part of what makes investment in shares difficult, and exciting, is there is so much to watch. It is not just about the share price, which can fluctuate wildly. (Taking a snapshot, which is not a good test, one share grew by 178% in a week; another dropped by 27.5%.)
Then, another thing to consider is the Price-Earnings ratio (PE). Leaving aside fluctuations in price, the PE measures growth in terms of dividends paid (usually annual). If the dividend is 10% of the price of the share (PE = 10) in ten years the value of your investment would double.
If the PE ratio is 3 or 4, say, your investment is going to grow slowly. The market labels shares according to their PE ratio. 'Growth' shares have a PE of higher than 10; 'Value' shares have a PE of less than 10. Which do you choose?
Look at what the markets and the economy are doing. Value shares are favoured when the markets are down, known as a Bear market. Growth shares are favoured when the market is up, known as a Bull market. This puts a different spin on the advice above, 'buy low - sell high', as it introduces another factor other than share price - PE ratio.
Again, the rules of diversification against your risk tolerance profile apply. By all means mix, judiciously, growth and value. But, as stated above, investing in shares requires constant attention.
When a government needs a capital injection - usually for major projects, such aas roads or power stations - they raise this money by asking investors to loan them money for a fixed period, with guaranteed returns at the end of the period.
The guaranteed rate is usually linked to prime lending rates at that time - so, the higher the inflation-rate is, the higher the return will be. However it is important to assess the risk before buying into a bond scheme. For example, I would not put any money into a bond raised by the current Zimbabwe government.
Bonds can be traded, rather like shares - so one is not locked in for the full term.
The Money Market is generally a safe - therefore very conservative - investment medium. The rate of return is linked to interest rates (prime lending rates). The higher these are, the better the money market will perform. This is a two-edged sword, as higher interest rates indicate higher inflation - which may eat into your profits.
I do not recommend Money Market for long-term investment. It is, however, a good place to hold funds while you accumulate a lump sum to invest elsewhere later.
Another good way of making a lot of money quickly is by setting up a lucrative business for yourself, or invest in someone else's lucrative business.
How do you know it will be lucrative?
The simple answer is that you don't. It may have as much chance of collapsing, and you will lose your whole investment. You will have to go on the quality of the business plan and your intuition. Would you have invested in Henry Ford's plan to manufacture motor cars?
Some years ago, when The US$-Rand exchange rate was over 12 Rand to the Dollar, accountants were advising clients frantically to invest offshore. The problem is that this introduced a second risk category, as investors were gambling on exchange rates. The result was that many lost 50% of their investment. Now accountants, having learnt from experience did you know that is possible? are advising clients to go money market. Yes, that is safe, and should form part of a diversified portfolio. As interest rates increase, money market options are going to perform better, as the money market rates are linked to interest rates.
So, what about offshore investment?
Trevor Garvin, head of multi-management at BoE Private Clients, said recently (Finweek Winter 2008 review of SA funds),
Yes, choose carefully, and spread your risk by adequate diversification across your whole portfolio, and choose more than one offshore investment if you go that route.
Investors should maintain an adequately diversified portfolio says Peter Brooke, head of Old Mutual Investment Group's SA's (OMIGSA) Macro Strategy Investments boutique. He continues (Finweek Winter 2008 review of SA funds):
Unit Trusts are set up by various ivestment companies as investment vehicles. Each unit trust fund will be defed within a specific market sector. The designation eg. a Growth Fund will often give you, the investor, a guide to the mandate that the investment company has given to the fund manager. Unit Trust investment portfolios are used extensively by pension fund managers and insurance companies when structuring the underlying investment in a client's retirement annuity (RA) or endowment policy.
The advantage is that, because the fund manager's job is to ensure that that specific fund performs within prestated parameters, the pension fund manager (or whoever including you) can adopt a basically hands-off approach and occasional look is all that is needed.
Most investment companies will allow you to buy a lump sum of units, or set up a debit-order system of drawing the amount you can afford each month. The second does not lend itself to easy diversification, unless you set up several debit-orders (at an ever-multiplying cost to you).click to go back up to index at top of this topic
Having selected according to your risk tolerance, which sectors of the unit-trust offerings you want to focus on you are presented with a daunting list of unit trust funds available to you in the media. Which ones will do what you expect and desire?
Firstly, it is helpful to get an idea of what the manager of any fund is trying to achieve. To do this you need to study the financial media, particularly Business Day, Financial Mail and Finweek. For example, let's look at a couple of examples (not named) from the Domestic Targetted Absolute and Real Return Funds sector:
TER = Total Expense Ratio (based on the previous calendar year), and reflects the underlying charges, fees and levies associated with the unit trust.
These funds fall in the conservative category. The aim of the fund manager should be to beat inflation by a fixed percentage (not high), and the advantage is that your capital is guaranteed.
What is the average inflation? Do not look at the latest figure! Over the past year it is perhaps around the 8% mark, so choose a fund that is doing (choose what) 10% or 11% or 12%. The first fund is below that on 1 year but is close on the 3 year range. The second fund is doing very much better about twice as well. This should sound warning bells for the cautious investor, as this looks more like a varied equity fund. The third fund is expensive and has shown a negative performance over 1 year. On reflection, I would probably avoid all three.
This topic flows into the next - Design your Portfolio.
There are two keys to ongoing successful investment:
This is your investment and financial future it is your responsibility!
If your portfolio is invested through an insurance product (Retirement Annuity or other investment product) be aware that there are costs deducted. So your tracking needs to be on the net amount actually invested.
How do you assess remedial action to be taken?
If you sell a fund that is showing negaitive growth you are taking a loss. If you do that repeatedly you will show a big loss.
Ideally, if you are going to sell anything, it should be at or near the top of a cycle. When you buy, the zone is at or near the bottom of the cycle.
An advantage of unit trusts is that the fund managers
will be taking remedial action within the fund to minimise
or hedge losses.
How do you track monthly (recurring) investment performance (e.g. Annuity Investments)?
These are not as easy to track as lump-sum investments, so, when you get a value statement from your insurer / service provider, see what the net amount (after commissions and fees) is that is allocated to the investment:
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