Willing to lose it all because you invested in equity?
Picture this for a moment.
A couple of 8o year olds strapped into the “Anaconda” roller coaster at GoldReef City. The rollercoaster’s plummeting at 100km per hour, dentures are rattling around in mouths, purple permed hair pulled straight back by the G-forces, and walking sticks flying around like heat-seeking missiles!
I think you’d agree that most retired folk would prefer a cup of five roses on the patio. But if you’re in your 20’s, then I’m sure a ride on “Anaconda” is right up your alley, correct? Check the video out below.
Quite simple – The younger you are the more risk you’re prepared to handle (Thinking back on my own life, the younger you are, the stupider you are as well).
So what are equities anyway?
Equity is a fancy word for shares. Shares are what make up the capital of any company listed on the Johannesburg Stock Exchange. Here’s a silly example – A company wants to raise a R1 million in capital and so it lists on the JSE offering 100, 000 shares at a price of R10 each. You and I snatch up their shares and we become shareholders.
Now if the company becomes a massive success – think Apple – then you and I become millionaires. If the company folds, you and I lose our shirts! Can you understand the risk and return potential of equities?
So what’s a rollercoaster have to do with equities?
Investing is very much like a rollercoaster ride especially in the short term. By short term I mean anything with less than a three to five year outlook.
This includes the 20 year old looking to save up for a car deposit, and the 80 year old wanting to preserve her nest egg.
Here are 5 questions you need to ask yourself before buying your ticket to ride:
- What return do I require on my investment? If you’re limited in terms of how much you can save, and you’ve got a massive target to reach, then you need to accept the risk that goes along with higher returns.
- What type of downside can I really stomach? This really applies to the guy who has a million already stashed. Is he willing to have that drop to R750, 000 overnight?
- Do I understand the risk and reward of investing? The higher the return the higher the risk of loss, and is the high risk worth the return?
- How long do I plan on investing? Do I have 20 years of investing ahead of me or am I 5 years out from retirement? Do I need the money for a house deposit in 6 months time or am I investing for retirement in 10 years time?
- Will I need income from this investment? Can I afford to have my income drop should my investment drop in value? If I’m reliant on a steady income then I need a stable investment with no surprises. But no surprises means no risk means lower returns.
Consider the example of someone approaching retirement…
What if all your eggs are in the equity basket and the stockmarket crashes? Overnight your pension fund loses a third of its value.
Or what about the person already retired and living on a fixed income…
The value of his annuity loses a quarter of its value overnight but he still needs to take R10, 000 a month in income. Taking R10, 000 from a R1 million means you’re withdrawing 12% of your investment every year as income. If that R1 million drops to R750, 000 overnight you’ll find yourself withdrawing 16% of your income.
Withdrawing 16% – or even 12% – when your investment is only growing at 10% is suicide.
The real issue here is time.
The more time you have to recover from a set back the better. The more you edge towards when you will need the capital, the less equity exposure you should take.
But without equities you’re dead in the water
You can play it safe and stay out of equities, but you’ll live with plenty of regret. There’s no worse feeling than knowing you could have earned a 12% return instead of the 5% your bank paid you.
Even someone on “pension” needs to have a portion of their capital in equities. If you think about it, businesses are in business to make a profit, right? If their costs of doing business increase, then they have few options except to increase their prices or lay off staff.
Bottom line is you want to own a portion of those businesses. Would you prefer owning the bank or settle for seeing the bank make a fortune off your money?