What are the key things I need to know before I start investing?

Key takeaways

  • Understanding a few basic concepts can make investing more meaningful.
  • Long-term investors take calculated investment risks with a view to achieving their goals.
  • Before you invest, decide if you are investing for growth or for an income.
  • Define your investment goal in terms of what you need your investment to do and by when.
  • Understand the risk you need to take to achieve your goal.


Starting to invest – perhaps on the recommendation of family or friends, or because you have been advised on an investment – is better than not starting at all.

But you can increase your chances of being satisfied with your investments, if you understand your investment goals and how you can achieve them.

Whether you work through these questions yourself, or get help from a good financial adviser, the answers hold the key to how and where you need to invest.

What is investing?

While savers delay spending to accumulate something worthwhile in future, investors look for returns to build wealth over long periods. Read more: What is the difference between saving and investing?

Long-term investors are also not traders seeking to make money over short periods such as days, weeks or months.

Traders buy and sell securities, such as shares, for quick gains, but successful traders are experienced and able to risk large losses.

There are fewer risks in long-term investing and you can be a successful long-term investor just by grasping a few basic concepts.

Long-term investors typically invest in the traditional asset classes such as shares, bonds, listed property and cash. They may also add some alternative asset classes such as commodities, private equity, hedge funds, infrastructure, physical property and currencies.

They use diversification and time in the market to mitigate the risks that come with investing in financial markets that are more volatile (can go up or down over short periods). Read more: What do I need to understand about investment risk and time? and Why should I diversify my investments?

Why are you investing?

Are you investing to grow as much money as possible by a certain date, or do you need to draw an income from your investment while it grows?

If you are investing for growth, you may have a target amount or investment goal you want to achieve – the amount you need by retirement, for example. You may be investing a lump sum, or smaller amounts more regularly, or a combination of both.

If you plan to live off your investments, as you may do when you retire, your aim will be to generate a reliable income stream.

You may need to focus all or some of your investment on asset classes that can provide an income – for example, interest-earning bonds, money market instruments or shares that pay good dividends.

Fixed income investments can give you a reliable income, but if you need an income for a long period, you will also need to ensure your capital, and the income it generates, grow to keep up with inflation. To grow your income, you may sacrifice some of the certainty about the income you will earn.

Investing to generate an income requires more planning than investing to grow wealth, as the implications of drawing from your investment must be taken into account together with the investment risk. Read more: What are the risks when drawing retirement income from investments?


What is my investment goal?

If you are investing for growth, the first things to work out about your investment goal are:

  • The targeted investment amount; and
  • The date by which you want to realise your goal.

Working out your targeted investment amount may take some research – for example, you will need to find out what degrees, diplomas or courses cost at appropriate learning institutions when saving for a child’s tertiary education.

Then you will need to work out how much that education will cost in future when your child needs it, by making an assumption on the relevant inflation rate.

If you are saving for retirement, work out your targeted investment amount based on how much of your current income you will need to live on when you retire and for how long you will live in retirement. Then you can calculate the sum you need to save to provide that income. Read more: How much do I need to save for retirement?

The date by which you want to realise your goal determines your investment term or horizon. If, for example, you are saving for a child’s education, or your retirement, at a particular age, your investment term is fixed.

The Smart About Money Savings goal calculator can help you work out how much to save to reach a goal amount by a chosen target date, or after an investment term.

If you are investing for an income, your investment goal should include:

  • The income you need;
  • The annual increase in that income; and
  • The period for which you need that income.


What is your required return?

When you are investing, the amount you will accumulate depends on:

  • How much you save;
  • How long you save for; and
  • The returns you earn.

If you are saving for a targeted amount by a particular date, achieving your goal depends only on two of these three factors:

  • How much your save; and
  • The returns you earn.

For example, if you want R50 000 in five years, and you can contribute R700 a month increasing by inflation each year of around 4.5%, you will need a return of around 7.5% a year to achieve your goal. 

But if you can only contribute R650 a month, you will need a return closer to 10% a year to achieve your goal.

The 7.5% or the 10% return you need to meet your goal by the chosen date, is referred to as your required return or investment need.

ASSET CLASS

AVERAGE RETURN

(relative to inflation December 1929 to December 2020)

SA cash (bank savings account or a money market investment)

The inflation rate plus 0.8%

 

SA bonds

The inflation rate plus 1.8%

SA listed property

The inflation rate plus 2.2%*

SA shares (equities)

The inflation rate plus 7.2%

 

 

Global shares (equities)

The inflation rate plus 7.4%

Multi-asset**

Inflation plus 5.8%

 

Based on relevant indices.

*Since 1980

** Based on a multi-asset fund index with a set allocation to each asset class, including 70% in equities.

Source: Old Mutual Long Term Perspectives 2021

Your required return must be higher than inflation. If your money earns less than inflation, it will be worth less each year, or if it just keeps up with inflation, it will not grow. Read more: Why must my investment beat inflation?

Returns are often linked to inflation. Investment and financial advisers therefore focus on the after inflation, or real return, you need. As long as the return target is a certain amount above inflation, it is less important what the actual inflation rate is. In the above examples, your real return would be 3% (7.5% minus 4.5%) or  5.5% (10% minus 4.5%).

The required return also needs to be realistic – a return you are likely to achieve by investing in financial markets. History is a guide, although you should always remember that past performance is no guarantee of future performance.

You can expect returns in line with the history of average annual returns for the asset classes - from one percentage point to seven percentage points above inflation - depending on where you are invested (see table).

However, remember that to achieve the average annual returns that have been measured over long periods for each asset class, you need to stay invested for at least the recommended term for each asset class.

What is the risk involved and can you stomach it?

Once you have determined the return you need, you need to check what level of investment risk you need to take in order to achieve that return.

Investing in cash will not earn much above inflation, but is unlikely to result in a negative return making it an option if your investment term is short. Investing in equities, will earn you the highest return above inflation, but comes with the greatest investment risk. Time can mitigate this risk if you have a long investment term and can tolerate the ups and downs in your investment value over the term. Targeting a high return above inflation over a long term will give you the most impact from compounding returns.

Read more: What do I need to know about investment risk? 

What is my risk profile and why does it matter?

Why is compounding growth so important?

The next step is to work out the most appropriate way to invest.