Thinking about passive income

When I was in 5th grade I had my first introduction to the stock market. One of my talented friends entered a competition where he had to write a song for the provincial Rugby team and won. He got some money and then did something nobody understood, he bought shares!

During his articles at an accounting firm he met a wealthy businessman and they started a property development company with a market cap of R11,5 billion Rand as I write this.

Why do I share this flashback with you? Because when he won the money, every single one of his friends (aged 10) could only think of the pocket knife he promised to buy every one of us. The way we think about life determines how we participate in it.

There are 4 main ways to participate in the income generating part of life and they are:

• Go work for somebody else (employee)
• Start your own business (employer)
• Buy an established business (owner)
• Buy a share in a business (investor)

Without making things to complex I want to put forward that the last one is the best one. The following reasons can be given:

• I do not have to work according to the rules of my boss.
• I do not have to worry about getting fired.
• I do not have to worry about the problems of my employees.
• I do not have to be at work 24/7 to ensure that nobody destroys my business.
• All my money is not tied up in one venture.
• I make money as I sleep.
• I can do my work from anywhere in the world.
• I do not have to worry about the politics of the country my business is in.
• I do not have to go through a lengthy process of selling my business or looking for another job.

The list goes on and on and on........

The beauty of buying a share in a business (buying a share on the stock market), is that you make friends with two very powerful forces:

• Passive income (dividends)
• Power of compounding growth

On top of that you can choose the best managers in the world in businesses that have proven themselves over decades!

I bought my first share when I was about 16 years old. It was a stock tip from a friend and it was a Gold Mining company called Jules. I made what seemed like a mountain of money on that share but for some reason the investment bug didn't bite. It was only when my love affair with working 12 hour days for somebody else faded that I "discovered" investing again.

What I am getting at is that anybody can start investing. You do not need to make it your job but it will provide you with the ability to generate the best returns with the money that you do generate from doing whatever you love doing and at the end of the day it can start taking care of you.

There are two very important things to remember when it comes to investing:

• The younger you start the better. The biggest secret to investing is to understand what you are investing in. It takes a long time to understand a company. To know what a good price is to buy it at and when it should be sold. You have to read all the news and listen to all the comments about it. You have to watch it for a long time before you commit to it.
• Only buy a share in a company if it is a company that you would like to be a part owner of for a long time. Sometimes it takes a long time for value to unlock. Speculating is fun but nothing else.

When I was growing up the mantra was "get educated so you can at least fall back on something, even if you don't like it". Unfortunately this is the truth, and for the majority of people the way it will be. The lucky ones are the ones that have a passion for something and can make a living from doing it. 

I say that if you can develop an interest in investing, you will never have to worry about living too long. Your passive income and the knowledge of investing in the right shares will provide you with financial independence or at least provide a healthy supplement to your normal income.

Beware!!!! Once you leave home and start buying those nice lifestyle assets, you might just never get out of the debt trap and having spare cash to invest becomes impossible! You have to get going with your pocket money while you still live at home! Like Warren Buffett said, very early on he realized that for every Dollar he spent, he could have made ten if he invested it!

TIP: get your children to read his books or read it to them. It is easy and very entertaining.

What to do with new money?

It was a spectacular 2013 and I need not say more on that. The year before, 2012 was even better so I cannot see SA equities delivering the same results in 2014 although some counters (Resources) had a dismal 2013 and could bounce if China starts growing again. The USA had a 27% (in $) return, also following a good 2012 and with the Rand depreciating 23% in 2013 SA investors smiled all the way to the bank.

Bonds will remain under pressure with interest rates going up rather than down so to answer the question of where to invest additional funds in 2014, I will say 50% in International Equities and 50% in SA equities for longer term.

Reason: Even if we get a very low 2014 for equities, I prefer not to time the market and regarding the international side, Developed markets still offer better value for money than SA and even though the Rand should strengthen against the $, there are no guarantees.

If my gut feeling is right, any Equity investment made by a SA investor will not perform much better than cash in 2014 but I have been wrong too many times to trust my own short term predictions and would rather just follow sound investment principals and get the money into the right place for the longer term growth prospects.

Some very unpredictable things can happen in 2014:

• The reaction to election results in South Africa
• The striking miners in South Africa
• The US tapering and debt ceiling handling
• China growth?
• Europe back into recession?

The good thing is that the US seems to be recovering well. That should at least stabilise many of the potential surprises.

Markets in 2014

The past week was an indication of what I expect for 2014. The South African share market came down by 4% and the Rand weakened by 4% while the Dow Jones in the US reached an all-time high. The SA market and Rand then bounced back a bit but the soft underbelly of our economy has exposed itself to what can be expected in 2014.

2013 has been another tremendous year for equities! SA is up 20% and the USA also. This follows a 2012 of 26% in SA! My prediction is for a volatile but flat 2014 in SA but good returns in the USA and Europe. There are 2 things that will dominate the markets in 2014 and they are:

·       USA tapering and
·       Growth in China

Fed Tapering is the process by which the central bank in the USA decreases the amount of money they pump into the economy. Why is this bad? Because it is like putting only a little petrol in your car instead of filling her up and still having to drive the same distance. You will naturally take your foot off the accelerator and if you are not over the steep mountain pass, you might just run out of gas before the downhill.

 
Tapering will only happen when the economy in the USA is strong enough to support itself and although short term traders in the market will sell some of their shares, the longer term outlook for global shares will be positive. Unfortunately for South Africa, this will make risk free investments in the USA more attractive (long bond yields in USA will go up), and the result will be the selling of SA shares and bonds to take back to the USA.
 
The double whammy for South African investors will be the further weakening of the Rand or at best little potential for Rand strength. Given the inability of our supreme leader to follow the good advice of his ministers like Pravin and Trevor, who understand that our trading partners and the people with money and power follow a capitalist approach, he still dwells in an African Tribal mindset where a R200 mil homestead and friends, rather than competent individuals in strategic government positions dominates his thinking.

 As for other asset classes like cash and bonds you will once again cry your eyes out like you did this year! Cash gave you 5% and Bonds 1%. Listed Property will follow bonds down initially but medium term I would start looking at allocating some money here.

 Once again we will wait with bated breath for China to come and save our commodities driven economy.  If Chine can manage a better GDP growth, say above 8%, our commodities will benefit a lot. 2013 saw another year where the shares in our market performed out of sync:

Industrials          30%

Financials           19%
Resources          2%        

So switching from overvalued financials and Industrials into resources will be a play lots of investors contemplate. All in all you have to stick to the sound investing principals of holding cash for 2-3 year expenses but committing longer term money to shares, some local but the majority overseas.

Financial Discipline

If you should receive all the money you would ever earn at birth, how would you spend it?

So let us say that your budget is R20 000 per month for 90 years. That will give you a lump sum at birth of R21 600 000. Now anybody receiving this amount of money at birth would probably die on the spot. But let us see what it really means.

Point number 1: With an inflation rate of 6% per annum, R21 600 000 today will buy you only R114 000 worth of goods in 90 years’ time! So you will have to earn a return on this amount of at least 6% to preserve the buying power of the money. This translates into an investment OTHER than a bank account because interest after tax will give you LESS than inflation.

Point number 2: There will be times where you will have to spend way more than R20 000 in a month to support your lifestyle for example when you buy a car or a house. The implication is that you will have to carry some of the monthly allowance over to an investment to prepare for those occasions. You will also have to determine how much you have to save every month to provide for a specific car or house BEFORE you buy it.

Point number 3: You will soon realize that as you grow older, your financial needs increases due to education, health and comfort reasons. When you are young the doctor can wait. You can sleep in a tent and only need to eat something to satisfy your hunger. In other words, you do not need the fancy stuff. This will give you the opportunity to make use of the power of compounding where if you leave the money in your investment, you will earn interest on the interest! This is where most people will fall into the trap of BUYING more than they need for whatever crazy reason!

Lastly, you do not know how old you are going to get so you will have to evaluate your financial plan continuously to ensure that you do not dip into your reserves to such an extent that you will run out of capital before you die.

THE SAME RULES APPLY for all of us earning our income as we go on and not in one single lump sum!

In summary:

·        Inflation will be your biggest enemy.

·        Provide for the big ticket items and make sure you can afford them.

·        Don’t waste money just because you have it. The lean years will come.

·        Formulate a financial plan early on and evaluate it regularly.

Markets for first 6 months of 2013

If you have been following the investment markets over the last 6 months you would have noticed 5 very distinct things being:

1.      The South African share market has been very volatile. It has gained 7% at its highest point and lost almost 4% at its lowest point giving it an 11% spread from peak to trough.

2.      The Rand has depreciated 21% against the US$, moving from R8.50 to touch R10.30 at one point.

3.      The US market has outperformed the SA market by more than 16% in US$ terms. Developed markets in general has outperformed emerging markets year to date.

4.      Listed Property and Bonds have been struggling.

5.      Gold, Platinum, Silver and most other metals have been taking a beating.

Looking at the under performing South African market one can name at least two culprits and they are the slowing Chinese economy and the lack of political talent. South Africa is very dependent on countries like China buying our mineral wealth and when there is a slowdown in the demand for our commodities, the price will fall. This will give rise to our imports exceeding our exports which will increase our current account deficit, which will be exacerbated by the weakening Rand due to foreigners taking their money out of South Africa to invest in the rising bond yields in the USA.

Another problem that faces the Rand is the inability of our government to manage the wage disputes and general well being of our economy which gives rise to an increase in the budget deficit, the downgrading of South Africa’s credit rating and ultimately the loss of confidence by international investors.

Looking at the rest of the world we can see a very confused investor public. Whenever there is good news about the growth in the US economy, the market goes down instead of up. This in mainly due to the fear of investors that the US central bank will start closing the tap on free cash. The signs of growth in the US is good news and that is why we have seen the share market outperforming the emerging markets like South Africa. It is about time for the shares in the US to gain some traction if you consider the poor performance for the last decade up to 2010. The US market has outperformed the Emerging Economies by 22% in $ terms year to date!

I am not too worried about the short term volatility in the markets and have been avoiding exposure to Gold, Listed property and Bonds for a while now due to the clear indications that they are either over valued or on the wrong side of the interest rate cycle. I have been telling my clients to increase their exposure to offshore shares because of the under performance of that sector and the strength of the rand over the last couple of years.

I am worried about the situation in South Africa and do not believe that the situation will be resolved over the short/medium term. Investing in South Africa will remain a higher risk investment than some of the developed economies and has recently increased that investment risk. There are two things one should do to mitigate this increased risk and they are:

1.      Ensure a well-diversified international portfolio. Focus on the USA

2.      Be very specific when selecting South African shares to invest in.

Investment mistakes we make, over and over.....!

A very wise man once told me in passing that you should sensor what you listen to and what you read. He said that when you are in your car, be very critical about the content on the radio and rather use the time to reflect in silence than to get worked up over an agitated caller's personal opinion.

There are 3 things I can think of right now that can be called the bully in the playpen. These 3 things will detract from your long term financial wellbeing as surely as filling your mind with crap will manifest in your daily life.

Instant gratification
Warren Buffett once said that he hates spending money because he knows that with every dollar he spends, he could have made $10 by investing it. Now if you do not know who Warren Buffett is, go Google him! People love to shop and some more than others. Miraculously there is always something you need urgently because it will do something extraordinary. Like, if you buy a new HD plasma TV you also need to buy a new HD DVD player and a sub-woofer to complete the experience.

Now that is all very "live in the moment" but just remember that one day when you are almost blind and probably deaf, that R1000 you spent when you were 30 years old, would have grown to over R230 000 when you turn 70 if you invested it in an investment yielding 15% return per annum.

Procrastinating
Such an ugly word but it does even worse with your potential investment returns! We all get caught by this one. I sold my house in November 2012 and "parked the cash" in an interest bearing account yielding 5.2%. I was busy with life, and waited for the Rand to strengthen to R8,20 to the $ because I want to invest in the USA stock market.

Well, here I am, still waiting. The R/$ is at R9,58 and the Dow Jones in Rand terms has gone up 20%. So I have made 2.5% return on my cash and my intention of investing would have given me 20%. We have to ACT when it comes to investing!

Investing on rumors and promises
This is a crap shoot, a roll of the dice way of investing. If you make money you are lucky and luck always runs out. Look at Sharemax, Kings etc. If you see your buddy making money on a share or some property investment, congratulate him/her and invest your money into something you know or into something with a proven history of performance and stability.

So don't just buy stuff, invest now and don't listen to hot gossip!

Investing 2013

What a fantastic surprise we got in 2012! The JSE gave us 27% including dividends and the S&P close to it. I was hoping for 12% return on shares. The amazing thing I take away from 2012 is how wrong we all are in our expectations.

January 2012 people stormed into my office, begging me to sell all their shares and to buy Gold. The big thing back then was that the EU was going to collapse and that Gold was going to hit $2 500 at the end of 2012!

Gold returned 6%, Inflation was about 5.8%!!! Gold shares like AngloGold returned -25%!!!

So if you sold your JSE share portfolio in Jan 2012 for R1mil and bought AngloGold shares, your LOSS would have been R520 000!!! This is something that will take you a very long time to recover from, if ever.

It is because of these emotionally driven disaster choices that people suffer financially, and the worst thing is that they then blame Shares for their predicament and make the mistake of keeping their longer term funds in Cash because their investment confidence got shattered!

I am convinced that the BIGGEST mistake we can make is to tamper with a well diversified equity portfolio. If you invest in 2 or 3 of our most successful (based on 7-10 years past performance) EQUITY Fund managers like Coronation, Foord or Nedgroup, you need not worry because with ALL the ups and downs, you will receive a good return after 7-10 years!

The Second Biggest mistake we make is to not build a relationship with a qualified licensed IFA (Independent Financial Advisor). I can give you 2 reasons why you should do it:

1. If you are still young and accumulating investments for future retirement, the IFA can work out a plan that will give you precise information on how much you have to save, for how long and in what.This plan can be monitored every year to see how you are doing.
2. At some stage in your life you will have to start drawing money from your investments (retirement). At that stage the IFA will know you well enough, and you will trust him/her enough to split your portfolio between the short term cash and the longer term equity exposure.

Regarding investments for 2013 I list the assets in order of preference:

1. Developed countries Equity.
2. Emerging Market Equity including SA (The Rand might be rather strong so no currency profit).
3. Bonds are expensive and when interest rates turn up they will suffer, so avoid.
4. Listed Property is expensive, as it has been for the last decade and keeps surprising on the upside but I will avoid it.
5. Cash only for short term expenses, it is not an investment.

Good Luck.