By Attila Kadikoy
Investors who have exited their business and are looking at what to do next are in the enviable position of having a lump sum to invest, and if they do so wisely, they could be set up for life.
Making the most of a once-in-a-lifetime opportunity for many business owners means more than just resisting the temptation to spend it on designer goods and fast cars. It's about carefully considering decisions that will have far-reaching consequences for your wealth once you receive the money and decide where to invest it.
When it comes to wealth, people tend to ask the wrong question: What return can I expect? That is not the last question you should ask. Instead, you should ask: What do I want to achieve with my wealth? What does this mean I need: an investment strategy that protects my wealth, one that grows it, or investing in a structure that enables me to leave it for my children and grandchildren?
Once you understand that, you can proceed with making a plan that matches your personal and financial requirements and that has the best chance of delivering on these within the time horizon most appropriate to your circumstances.
Understanding the foundations of any successful investment strategy
- The foundational pillars of creating an investment strategy are understanding risk and recognising the crucial nature of diversification in minimising the profound impact these risks could have on your wealth.
- There are two types of risks: erosive and catastrophic risks. Erosive risks are those factors or events that erode the value of your wealth over time unless you minimise or mitigate these risks in your investment decision-making. These risks include:
* Inflation steadily erodes the value of your wealth over time if you are not consistently achieving positive real (after-inflation) returns.
* Tax inefficiency can be costly if you don't structure your investments to minimise the tax you pay.
* Rand depreciation, which reduces the value of your investments in hard currency terms and can be protected by investing globally in dollars, euros or any other developed market currency that holds its value better than emerging market currencies.
* High fees eat into your returns annually and cost a considerable amount in the long term.
* Making the wrong investment decisions will prevent you from achieving the financial results you want and need over time. Examples include investing in an income fund when you do not need income for decades to come or invest in a high equity or equity-only portfolio when you should be protecting your wealth.
The other type of risk is catastrophic risk. Though the name suggests these are rare, you would be surprised at how many of these could put your money at risk throughout your lifetime. These include black swan events which are unanticipated macro-economic, financial, or geopolitical risks that seemingly arise out of nowhere. The Great Financial Crisis, when it seemed that the banks were all going to fail, is one such catastrophic black swan event - and there have been several over the last few decades. Other unforeseen risks that could suddenly eat into your wealth include litigation or divorce, which involve significant sums you haven't allowed for in your financial planning.
Diversification minimises risks to your wealth
Risks are by nature virtually impossible to predict, but diversification is a powerful tool for investors seeking to manage potential risks. Deemed as the only free lunch in investing, diversification spreads the risks across the portfolio so that if one type of risk hits the portfolio, it may adversely affect some of the assets, but not all of them.
For instance, global diversification by investing a portion of the portfolio offshore protects investors from the risks of investing in South Africa. Typical risks include the highly concentrated nature of the South African stock market, the JSE that has far fewer stocks to choose from than are available globally. All are subject to the same emerging market macroeconomic and geopolitical risks.
According to Investopedia, there were about 55 214 listed companies worldwide as of December 2023, compared with the 400 companies listed on South Africa's main and AltX's boards. Similarly, by investing in the US, Europe, and the UK, investors get access to a plethora of bonds, many of which provide safe havens from the volatility experienced in emerging markets like South Africa.
Volatility doesn't result in capital losses - it creates opportunities. Volatility also needs to be viewed in a new light. Most investors fear volatility because they believe it could result in losing money. But we view it differently. Volatility shouldn't be considered as an absolute loss. It often provides an invaluable opportunity to buy or sell assets at attractive levels. For instance, long-term investors who are not planning to tap into their investments for a long time can take advantage of the fear and panic of global crises by buying quality assets and trading at lower prices.
Volatility only becomes an issue when you are constrained by time because you want to take your money out, but doing so at that point in the market cycle would result in actual losses.
Leaving a multi-generational legacy wherever your beneficiaries lay their heads
Business owners who have exited their businesses and want to leave a legacy for their children and grandchildren will need to consider other factors besides the investment strategy that best suits their purposes.
Thus, your wealth needs to be considered from a multi-generational perspective. In this event, estate planning will be a significant consideration when deciding where to invest. From a South African perspective, there is a strong likelihood that your children may not remain here and thus might have to access their wealth in a different jurisdiction when they inherit it. Tax and estate planning considerations should be prioritised to ensure that any structures created to house the proceeds of your business exit are transparently compliant and by the country's tax regulations.
For all these reasons, it's crucial that you don't buy off-the-shelf products arbitrarily without putting in the hard work to determine what strategies and structures will best position you to achieve your wealth goals.
Adopting this approach is particularly relevant when you have decided to get worldwide geographic investment exposure. The global investment options are virtually limitless, and unless you have put the hard work into developing a sound understanding of the investment strategy you need to achieve your goals, you could quickly be putting your hard-earned wealth at risk.
* Kadikoy is a managing partner, Levantine & Co.
PERSONAL FINANCE