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By Gustav Reinach*
One of the most important goals for any investor is to avoid losing money, which can be done easily enough if you lower your risk. However, investing only in low-risk assets will deliver below-par performance and possibly lead you to missing your investment goals.
Which is why you’ll hear advisors like myself repeating the same old mantra: diversify, diversify, diversify.
What this does is spread your risk across different asset classes so that, if done properly, one asset class will outperform when others underperform.
Take this example of the difference in how two different funds have performed between June 2017 and September 2021.
The red line represents the returns of a fund that has 50% exposure to international equities, whereas the grey line is that of a fund with 50% – 60% exposure to SA Equities. With annualised growth of nearly three times of the SA-focused fund, the benefits of diversifying offshore have been hugely beneficial.
A common misconception about diversification is that simply spreading your risk across multiple asset classes is enough.
However, every portfolio and diversification strategy will differ based on each individual investor’s needs and priorities. And crucially, your investment horizon.
I believe that if you have 10 or more years before you need your capital then there’s no reason why you shouldn’t be invested 100% in equities.
Your diversification strategy in such an instance would then focus on divergent sectors or themes, as well as different geographies. As the above graph illustrates, having merely 50% of a portfolio invested in offshore markets produced remarkable outperformance over locally-focused strategies.
The closer you are to retirement, the less risk you want to take in case markets hit a speed bump. This can have a disastrous impact on your investments if you don’t have sufficient time before retirement for prices to recover.
I recommend that if you are five or less years from retirement that you can start tapering down your exposure to equities to the point that you have about 70% of your portfolio in cash and bonds.
Shorter investment horizons – if, say, you’re saving for a deposit to buy a house in three years – then you would also want to diversify your portfolio. Once again, I suggest a maximum of 30% in equities and the remainder in cash and bonds.
Diversification within asset classes
As already mentioned, 100% exposure to one asset class like equities makes sense under certain conditions. The times it makes most sense is when you still have a long investment horizon that would allow you to recover if the market dips.
Apart from diversifying across sectors, you can get further diversification by looking offshore. I believe that this is essential for South African investors to produce long-term outperformance.
The wider scope of investments and investment opportunities outside of the country, alone, is reason to spread your risk across borders.
Don’t discount SA bonds
I’m certainly not advocating that you abandon all local assets, because there is still value to be found. Particularly in local bonds.
We are still comfortable with SA because, in real terms, they deliver the best yields for what is a conservative asset class. In addition, they are a great combination with offshore equities because they are negatively correlated.
This delivers the ideal counter-balance in a portfolio that ends up giving you a smoother ride over the longer term.
Money market and cash
Conservative assets like cash and money market investments are less popular because of the effect of inflation eating into your capital.
It makes sense to have some liquidity in local currency if that suits your lifestyle, but I would suggest holding no more than 8% – 10% of your portfolio in cash. Having cash on hand also presents the opportunity to profit from cheaper-priced equities if there’s a big market correction.
If you’re inclined that way you might want to hold aside some liquidity to take a punt on occasional opportunities. This approach doesn’t suit everyone but does allow the more adventurous investor to keep some money available to invest without fear of upsetting the entire portfolio with a long shot side bet.
- Gustav Reinach is a financial advisor at Brenthurst Pretoria. [email protected].