The balancing act of financial planning


Sollie Goosen, Advisory Partner – Citadel


sollieAmerican financial historian and economist Peter L. Bernstein describes the market as being “not a very accommodating machine: it won’t provide high returns just because you need them.” In times of low market returns and high uncertainty, this can be a tough truth to accept.

To ensure that your capital lasts your lifetime, it is important to manage the two risks of volatility in the short term and inflation in the long term, in order to achieve your goals and objectives. When constructing a financial plan, certain assumptions have to be made. These include the inflation rate, the projected rate of return above inflation of the funds selected, and the fact that your future goals and current circumstances won’t change drastically in the short term. (As your needs and desires do change over time, your financial plan would need to be reviewed regularly and revised when necessary).

The trouble with crystal balls and economic projections is that they cannot tell you what is going to happen with absolute certainty. For this reason, investors have to be prepared to accept a reasonable range of outcomes for financial planning purposes. This is particularly important when it comes to keeping your emotions and behaviour in check so as to stick to your financial plan, even when it seems like the proverbial investment sky is falling.

Market cycles and investment styles

As markets move in cycles, the dynamics influencing performance shift. Accordingly, different investment strategies fall in and out of fortune as each strategy is better suited to certain market conditions over others.

For example, as Patrick Cairns points out in a recent Moneyweb article, the past four years have seen one of the most protracted periods of value investing underperforming growth investing in the local market.

This phenomenon is not unique to South Africa and similar trends are playing out in overseas markets. This is largely a result of the 2007/8 global financial crisis, which negatively affected economic growth around the world and caused investor panic.

A growth investor would typically buy stocks in anticipation of increased earnings or market performance, whereas a value investor would be more concerned with the underlying bricks and mortar value of the business. A value investment style produces dependable returns in the longer-term, but would certainly lag in a buoyant market.

The father of modern value investing, Benjamin Graham, put it rather well when he remarked that in the short-term, the market is a voting machine, but in the long-term it is a weighing machine.

In an environment where economic growth and corporate profits are down, the returns of funds which adopt a value investment strategy suffer the same fate. Applying supply and demand principles: when the price of a share increases at a higher rate than the underlying earnings growth, it becomes overpriced. For this reason, since the global economic crisis, expensive stocks have become increasingly overpriced and cheap stocks increasingly undervalued. The disconnect between price and value has become more marked and is remarkably acute at present, to the chagrin of value-style investors.

Accordingly, funds which are managed by a value investment house have delivered subpar returns. This further highlights the need for sufficient diversification to mitigate against the kind of extraordinary circumstances we are experiencing now.

It is necessary to employ a range of different investment solutions, each with its own risk/return characteristics and investment time horizon. Diversification is key. Just as you need to blend asset classes to achieve good returns with an acceptable level of risk, so too you need to blend different investment strategies within a portfolio to mitigate against the turn of market cycles.

Investing is complex and not for the faint of heart. It is important that you understand the investment philosophy used by your fund management team to grow your wealth and the broad trends playing out in the market.

Asset and liability matching

At The Wealth Corporation, to ensure your capital lasts your lifetime we carefully manage the twofold risks of volatility in the short term and inflation in the long term. In doing so, we employ a range of different investment solutions, each with its own risk/return characteristics and investment time horizon. Your short-term income needs are provided by a money market fund and your progressively longer-term needs are provided for by cautious, diversified and growth funds respectively.

Each investment solution has a strategic asset allocation that is designed to achieve the required rate of return at the minimum level of risk. We manage volatility risk by means of diversification as various asset classes react differently to economic cycles, political uncertainty, interest rate changes and currency fluctuations.

As the investment market is an “unaccommodating machine”, it is important that your advisor walk the road to your retirement with you, providing the kind of clarity of thought and emotional support needed to stick to your financial plan and so avoid making costly mistakes when either fear or greed creeps in.