Safe Investing

Sound investment advice for volatile times

Is there such a thing as safe investing?
Investment markets over the last month or two have been about their most volatile in recorded history with one day presenting positive returns of up to nearly 6% and on the next day presenting investors with losses of nearly 7%.

Volatility in the market is measured by the JSE and is published as the South African Volatility Index (SAVI). When returns on the equity markets are volatile the SAVI tends to move upward.

It is especially difficult to be in this market when one is drawing from capital. Safe investing strategies are important in such times.

Most retirees are redeeming a number of units of their investments to give them a monthly income.

As the market has started coming off, the value of the units have become cheaper and retirees are being forced to redeem a greater number of units to have the same monthly income let alone a higher income.

Just Three

There are many safe investing strategies which are aimed at taking the sting out of a volatile market. To keep it simple, let's look at three such safe investing strategies in broad terms.

1. Diversified portfolio strategy for Safe Investing

This aims to achieve a certain targeted rate of return. This strategy aims to invest in a diversified portfolio of cash, bonds, property and equities.

The investor having decided on a particular strategy which should over time deliver returns to provide them with a particular income.

He draws from the entire portfolio over time and no decision has to be made from which assets to draw or when to draw.

This eliminates timing risk to a large extent.

2. Bucket strategy for Safe Investing

This strategy will set aside a portion of cash to meet the income requirements for a particular period. The cash set aside will then be invested in a money market investment which will earn interest.

The risk and volatility with such a money market investment is very low and the capital for that particular period is virtually guaranteed. The remainder of the investment portfolio will remain invested in the market.

This approach gives one some degree of comfort, since they are not making withdrawals from their investment portfolio when equities are falling and they are only withdrawing funds from the portion of their portfolio which is invested in the money market.

The strategy can be complicated to administer and can be costly if one takes into account switching costs and capital gains tax implications.

There is also a fair degree of timing risk as the investor will be required at the end of the period to make switches from the market into cash.

3. Life Stage strategy for Safe Investing

The distinguishing feature of life stage funds is that the overall asset allocation of the fund automatically adjusts as the expected retirement date approaches. Your overall asset allocation would tend to be moved from aggressive assets like equities and property while you are young and into more conservative assets like bonds and cash as your retirement age or date approaches.

The life stage strategy is easy to understand and to maintain, yet it does not solve the problem of timing risk as the date of your birthday determines when you move out of equities.

The question as to which approach is most appropriate is a very complex issue and will depend on how the market is behaving. Research indicates that on average the value of the investment portfolio where cash is set aside or where life staging is implemented is in most instances lower than where a diversified portfolio targeting a specific rate of return is used.

However the results may be different should there be a long and sustained bear market.

A large reason for the difference is due to asset allocation. Asset allocation is the allocation of your money between equities, bonds, property and cash.

The client’s asset allocation becomes more biased towards cash in the life stage and the bucket approach.

The client is better protected when equities are not doing well as is currently the situation but the investor will lose out in periods when equities are doing well.

Over the long term equities have produced far better returns than cash, although they have not been as smooth.

It is imperative that you discuss the above safe investing issues with a trusted professional.

Netto-Jonker, CFP, is founder of Netto Financial Services and was financial planner of the year in 2001. Her business partner Ian Beere, CA(SA) CFP was the financial planner of the year in 2007.