Imagine living in a world where you knew everything about the future with certainty. There will be no surprises or pleasures – that is because you knew all along what will happen. Your first day at school, your first kiss, your marriage proposal and the birth of your child, would be as exciting as last year’s weather report. If our world ever became certain life, I am sure life will be boring. However, we demand this certainty from financial advisers and recently political analysts. Is what they are giving us certainty or just lies?
Many of us smile at Sangomas when they interpret dreams and their symbolic meanings. However, when the same Sangomas work with numbers, wear business suits and have finance degrees, we take their prophecies seriously and are prepared to pay for them. No one likes having to invest for the future under the assumption that the future is unknowable. We all want to know what will happen in the future to help us invest but predictions about the future investment returns are likely to be wrong, and nobody knows by how much and in which direction. So why do we use these predictions to make incredibly important decisions about our money? The answer is simple: we hate lack of control.
What happens if we tell clients that we do not know future returns?
We quickly lose credibility and officially become members of the “I don’t know” school of thought. This becomes even more worrying for us when potential investors tell us about another adviser that has promised them a better and guaranteed return. If you have recently bought a product that promises a guaranteed return or offers a cash back bonus at purchase, you may want to check if what is written on the packaging is what is on the inside. I doubt that you will be happy with your findings. If the adviser who is telling you how to make money in a few months, had perfect foresight about the future, he would not be talking to investors. He will most likely be retired, relaxing in an island and at the top of the personal finance best-seller list.
If we do not know what the future holds, how do we invest?
We do not mean to suggest that if we cannot figure out what the future holds, we cannot understand what is coming next. We do believe that understanding the present will give us valuable insight into future returns and if they are below or above realistic expectations, and that is all we can hope for. According to a recent update, the South African equity market index gave investors a net total real return (before inflation) of 13.2% over the 111 years from 1900-2016. This 116-year period includes all imaginable political and economic events such as the Rubicon speech, Soweto uprising, first democratic elections and the firing of finance ministers. As an asset class, bonds have delivered 7.8%, and cash delivered 7% in nominal terms over the same period. These returns are what passive investors should realistically expect to earn over time.
You need to know the return required to meet your goals
Most investors that need financial advice have a target return in mind for their investment. It is usually higher than what the market offers. After all, who does not want higher returns? We can refer to this return expectation as a desired return – a return target based on a want more than a need. Our role as financial advisers is to estimate the return you require to accomplish your objectives, taking into account your unique goals, time horizon, current asset base and risk tolerance, among other factors. Most of the time we find that the return required to achieve your goals is meaningfully less than your desired return. Understanding the difference between required and desired returns can serve a very important function setting financial goals and action steps to make your life dreams a reality.
Align your goals, with reasonable return expectations
We encourage investors to have realistic return expectations, based on long-term historic experience rather than the recent history. If you have realistic return expectations, you can plan timeframes and take appropriate risk for achieving your goals. It will also help you stay the course and avoid making emotional short-term investment decisions. Think hard about what you want relative to your financial goals.
Head of Investments
Sphelele joined Inkunzi Wealth Group in 2013 and has 9 years’ experience in the investment management industry, having had previously worked for Allan Gray and Regarding Capital Management. Apart from being an active member of our investment team, Sphelele is also responsible for the management of our business. He holds a BCom degree in Economics from the University of Pretoria.