Steven Nathan / 4 June 2017 00:05

The journey to financial freedom starts and ends with saving and investing. A few trust-fund babies and entrepreneurs apart, the only way to walk this path is to spend less than we earn and put the difference to work.

Ahigh income alone does not guarantee a secure retirement. Sports Illustrated drove this home once when it reported that 78% of NFL football players and 60% of NBA basketball players suffered financial stress within five years of retiring. There are also plenty of tales about film and pop stars who ended up broke, and lotto winners now on the dole.

These celebrities don’t just succumb to lavish lifestyles, they fall prey to elementary investment mistakes. The specifics may differ but the themes underlying these failures are as universal as they are avoidable.

Unfortunately, we are all susceptible to the same pitfalls. Here are a few personal case studies from individuals who learnt the hard way.

My RA: high fees, not enough risk

Chris: “As soon as I started my first job, I took out an RA. The broker recommended a “medium risk” portfolio and locked me into a 15% pa premium increase for the next thirty years, “to keep abreast of inflation”. The R1 million illustrative nominal maturity value at age 55 seemed like a fortune at the time.

He made no mention of any early termination “penalties”, and did not speak about fees (above 3% pa). Even if he had, I would not have considered how they would reduce my maturity value (by 26%). I also did not think about the purchasing power of R1 million in 2018 and how investing in a medium rather than a high equity portfolio would diminish my long-term return.”

Like so many other uninformed investors of that time, Chris was duped into buying an inflexible high cost, low return savings product that would barely pay back his premiums one day, adjusted for inflation. Projecting the maturity value in nominal rather than inflation-adjusted terms created a false sense of future wealth.

Today’s young investors are much better off. There’s a load of financial education online, warning of these risks. They are also not limited to life insurance; many asset managers now sell RAs direct to the public, at much lower cost, on flexible terms and without punitive early termination penalties.

My discretionary savings: inadequate diversification, discipline

Richard: “My discretionary portfolio holds my favourite shares, very much “buy and hold” stocks with a solid long-term growth record and decent dividend yields. Although I spread my money across industries, countries and currencies, it proved to be insufficiently diversified. The collapse of the MTN share price left its mark.

I also own preference shares, which delivered a tax-free cash flow until the government started taxing dividends, impairing both their income and capital value. I have also not been disciplined in reinvesting dividends. My portfolio has grown decently over the years, but nowhere near the average market return.”

Buying individual shares is a mug’s game. The chances that you’ll load up on Naspers at R40 and hold on all the way to R2 000 are slim; the risk that one or more of your stocks bombs is enormous.

Certainly, as far as your serious money is concerned, the lesson is to avoid stock-specific risk and invest in a broad index fund instead. Even the smartest professionals cannot reliably beat the market, so there is no reasonable hope for hobby investors.

My pension fund: failing to preserve

Declan: “On leaving my former employer at age 29, I cashed out my retirement fund and bought a car. What I didn’t consider was that this would not only cost me my savings, but also the future return thereon. This money would have grown six or seven-fold by retirement. Cashing out has taken a big chunk out of my pension and makes for a very expensive car.”

According to industry surveys, between 70% and 80% of employees don’t preserve when they change jobs. Younger employees, especially, are full of hubris that they have time to make this up. They don’t appreciate the long-term value of those early savings. For example, in the context of a diligent 40-year saving plan, the first two years’ contributions already fund 10% of your pension.

The sensible option when you change jobs is to transfer your savings to your new employer’s fund or to a preservation fund. This preserves not just your savings and tax benefits, but also keeps your money growing, until you do claim.

According to surveys, our single biggest regret at retirement is that we didn’t save more. Fortunately, that risk is under our control. Investing also invites regret. Wherever we put our money, there is always another stock, another portfolio or another strategy that, with hindsight, did better. Some regrets are avoidable though, namely those that relate to taking on unrewarded risks:

  1. Inadequate diversification (over-exposing your money to individual investments);
  2. Going too conservative on your asset mix (long-term investors putting too much money into defensive, low growth assets);
  3. Market timing (deciding when to move money in and out of cash);
  4. Manager selection (investing with fund managers who underperform);
  5. Over-paying on fees (more than 1% pa).

Fortunately, it’s possible to exclude ALL these risks simply by investing in a broadly-diversified, low cost, high-equity index fund and holding on for the long-term. That’s Warren Buffett’s “best advice” to investors.

Steven Nathan is CEO of 10X Investments