CN&CO is delighted to be working with OUTvest. The team, under the leadership of Grant Locke (right) and Neil de Bruin (left) – you will go a long way before you find two people who are smarter and more passionate about what they do! – have as their mission to educate South Africans about the value of advice in making investment decisions.
One of the things we have loved working on with the team is learning that we may, in fact, be worse off than previous generations because we finance via debt, not savings and investments. It is so easy to access (expensive) debt that we use to pay for more for stuff than we should. But you’ll see more of that in the campaigns we are rolling out – and please let us have your feedback.
Since we work in a space with various clients on investment, savings and trading, we asked Grant to help us put some clothes on the emperor. It has been our experience that many, many people – including those who work at companies that offer investment products – have little understanding of the basics. And as Grant is an ex London stockbroker, blossoming entrepreneur, super smart, awesome father and generally a top notch guy, we knew he would be the man for the job. So here are your questions around investing, trading and savings answered!
Q.1. What is saving?
To save is to put aside money to pay for something within a year or so. The money should be accessible, and should be in a short notice deposit, or a money market fund. Once you plan to invest for a goal you want to reach in two years or longer, then you should consider investing towards that goal instead.
Q.2. What is investing?
To invest is to aim to grow your money faster than inflation to reach a goal more than two years in the future. All investing comes with the risk that you may lose money. What confuses many people is that you could just as easily lose money when it is in a bank account or a money market fund. This is because over longer periods it is less likely that your money will grow faster than inflation. In other words, even though your money grows, the prices of things you want to spend it on have grown even more. This is especially true with the cost of education, which has been rising at over 8% per year since 2008. It could be difficult to find a savings account that will provide an interest rate as high as 8% over a long period of time.
Q.3. What is trading?
Trading is buying and selling of different investment types on a daily, weekly or monthly basis. The primary aim of trading is to profit from the change in price of an investment. For example, a trader decides that the price of Anglo American Plc will rise today as a result of some news about the change in the price of platinum. A trader will quickly buy and hope to make money in the next day or so, and then sell the stock and research another trade idea. Some traders can even make money by taking a bet that the price of a share will fall. Each trade is an instruction to buy or sell a certain investment type, such as a share, a bond, or even a currency.
There are three extremely important aspects of trading to be aware of. The first is the use of what is known as ‘margin’. Margin is the ability to buy or sell by borrowing money from your brokerage. For example, if you start trading with R1 000, some brokerages may lend you another R9 000 to start trading. This means you can start trading with R10 000. What is sometimes not understood is that if you lose money on your trades you could be liable for the full R10 000 and not just the R1 000 you invested in the first place. Using margin to fund your investments is definitely not a good idea unless you know you can repay all of the money you borrowed.
The second aspect to be aware of is the cost of trading. In many cases each trade will incur a cost – which could be called brokerage cost, and in some cases you could be liable to pay tax. When you trade only a small amount of money the cost of each trade may be extremely high and it may be difficult for you to generate enough profit on each trade to pay for your trading costs and make a profit.
The last aspect is tax. It is important to remember that any profit you generate on trading could be subject to income tax and you will have to declare your trading profits on your tax returns, so it is very important to keep money aside to make sure you can pay for this.
Q.4. What are the fundamental differences between saving and investing?
Saving is generally for short-term goals, such as your emergency fund, holiday or wedding, or any goal where you may need the money within the next year or so. With saving you aim to make sure you don’t lose money in the short term, and this is the reason why a bank account or a money market fund is suitable.
You will generally invest for longer term goals, and your aim is to try and grow money faster than inflation. This can be done using a combination of investment types, for example shares on a stock exchange, government bonds (loans to governments), property and commodities. These investment types can be bought individually, or together in the form of a unit trust or an exchange traded fund (ETF).
Q.5. What are the fundamental differences between investing and trading?
When you invest, your aim is generally to leave the money until you need it. When you invest, you don’t plan to change what you invest in very often, if at all. When you trade you have to constantly look at the performance of your trades to ensure they are making money, taking into account your costs. Generally speaking, individuals who invest and those who trade can invest in the same types of investments, i.e. shares listed on a stock exchange, bonds, property and foreign currencies.
One of the main differences between trading and investment is how often you look at the money. Traders usually watch their money during the day, investors tend to look over their investments on a less frequent basis.
Traders also have access to extremely advanced investment tools, including derivatives, which, although powerful, are extremely dangerous financial tools and have the ability to destroy financial wealth, especially when used in conjunction with borrowing.
Q.6. Please give an indication of the possible returns from each of the above
When building OUTvest we looked for and found one of the longest historical sources of the performance of different investment types available. The data we use in our business for our systems goes back over 115 years.
For savings, if you had invested for a period of one year during the past 115 years, we estimate the interest you could have earned on average is about 6%.
If you had invested for a period of five years during the past 115 years, we estimate that you could have earned a return of around 13% per year on average, before fees. It’s important to note that there were periods where you could have lost money, even though you invested for five years – but not as many as you think.
We think it is impossible to estimate a possible return from trading as each trading strategy is completely individual.
Q7. Is there a recommended ratio of savings: investment: trading?
To be clear, unless you dedicate your full time to trading and you have some form of experience in the industry, we don’t think trading is a good option. We believe that while you should have some form of savings – for example, for an emergency fund and other savings goals, you should try and have more in long term investments than you have in savings. Although, it really does depend on your individual circumstances.
If you have never had any savings or investments before, then you could start with an emergency fund. It’s a great way to reduce your reliance on debt to pay for unexpected expenses such as an illness, or perhaps a car repair bill.
Q.8. On what sort of occasions or objectives is it recommended to use each of the above?
The objective of trading is to generate as much profit as possible, however, this is much more difficult than most realise and it’s generally not as easy as generally advertised. With investment you will generally invest towards important personal goals such as a child’s education or your retirement. When you save you generally try and save for a holiday, a wedding or your emergency fund.
Q9. Can you give examples of
(i) typical savings instruments/vehicles/institutions?
(ii) typical investment instruments/vehicles/institutions?
(iii) typical trading instruments/vehicles/institutions?
(i) Savings: Typically a savings account or a 32-day notice deposit or fixed deposit, up to and around a period of one year. A money market fund is also a good option for saving as the interest rates can be quite attractive and you can usually deposit and remove your money whenever you want to.
(ii) Investment: One of the reasons why most people don’t get started is that there is simply so much choice available. There are over 1 500 unit trusts available in the market, and over just under 400 listed companies on the Johannesburg Stock Exchange. There are also government bonds and other instruments. Even all this is a drop in the ocean when you take into account your ability to invest offshore. When you want to invest, then it really is a good idea to get some advice – and you could consider a robo-advisor.
(iii) Trading: When you trade you can access the same instruments as when investing. This is in addition to derivatives such as swaps, options, futures and forwards. These instruments allow you to profit from the change in price of an investment without having to own the investment. However, these are extremely advanced investment tools and should only be used by investment professionals.
In the words Warren Buffet, one of the worlds most famous investors, “In my view, derivatives are financial weapons of mass destruction.” And in my view, if they are not used properly, they can blow you up financially, too.