How can I invest R1.5m for income and capital growth?

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Dear Reader,

Before we begin, I think it’s important that you ask yourself a few simple questions. How much do I have to withdraw monthly? What is the investment period? Am I willing to take more risk to get higher returns?

As an investor, you typically don’t want to withdraw more than 4-5% of your portfolio value per year. With a 5% annual drawdown, you can withdraw R75,000 per year and R6,250 per month. The basic principle of capital depreciation is that growth must exceed drawdown. If you need a 5% drawdown, your capital needs to grow by 5%. If you need an increase in the Consumer Price Index (CPI), your fund needs to grow by 5% plus CPI to accommodate the increase. If you need an annual increase, the risk you would have to take changes drastically from an income that doesn’t require an annual increase.

When people think of interest rates, they usually mean money market funds or deposits at a bank.

The average managed money market fund has returned 6.14% over the past five years. If you had invested in a money market fund over the past five years, you would only have had a real return of 1.8%, with inflation averaging 4.34% over that period.

Money markets aim to provide protection of capital while providing a solid level of income. However, you must understand that these funds do not aim to provide long-term capital growth. Money market funds are a good tool for transitional money, short-term saving, or as an emergency fund, but not for long-term investments.

When building an income drawdown portfolio, you should take full advantage of diversification by introducing money market, fixed income, and local and offshore investments to achieve sustainable long-term growth.

Personally, I like to use a bucket approach where income and growth wealth are split into different sections as they serve different functions. The income bucket would typically be a fixed income or money market instrument and this is for income purposes only. The other part is divided into growth assets, which aim to achieve long-term capital growth and replenish the return pot after a certain number of years.

Below are the one year, three year, five year and 10 year performances of the same investment house but different funds.

Funds shown are money market funds (light grey), SA balanced (red), SA equities (black) and global equity funds (grey).

Annual performance

You’ll find that the money market delivered the most stable returns compared to the other three funds. The global equity fund struggled the most over the past year and was the worst performer. The Balanced and SA Equity Fund delivered positive returns that outperformed inflation and outperformed the money market fund. If you were invested in the global fund, you would have been the loser last year.

Three-Year Achievement

You’ll find that the money market again delivered the most stable returns compared to the other three. The global equity fund outperformed the other three funds quite comfortably. The Balanced and SA Equity Fund delivered positive returns that outperformed inflation and outperformed the money market fund. Had you been invested in the money market fund during this period, you would have been the loser over the past three years.

Five Year Achievement

Again, you’ll find that the money market produced the most stable returns compared to the other three funds, managing to generate nearly the same returns as the SA Balanced and SA Equity Funds over a five-year period. The global equity fund outperformed the other three funds, outperforming the money market fund by 16%. If you had invested in the money market fund, you would have received almost the same growth as the SA Equity and SA Compensation Funds.

10 years of performance

This is the point where you see the difference in growth and the risk is rewarded. The riskier funds can go through different market cycles and generate real returns. The global fund delivered 367%, SA Equity 162%, SA Balanced 158% and the money market fund 85% growth…

Finally

While past performance is not an indicator of future performance, the basic investment principle remains the same.

Short-term funds offer stable, low returns.

Long-term funds will be volatile, there will be (definitely) downside moves in the fund, but given enough time, they will deliver real returns. You must be able to absorb these short-term moves in order to enjoy the long-term returns.

Find out about your income needs and speak to a professional who can give you the right advice and meet your expectations. Know the difference between your willingness to take risks and your ability to take risks. Your ability to take risks may differ from your risk appetite, which can lead to stress. A professional advisor will be able to balance your portfolio and find a happy medium.

You are welcome to contact me at any time.

Enjoy your retirement!

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