Why a predetermined process is better than reactive behaviour

By Deidré Valentine

1/10/2022

It is almost the end of 2022, and the new year is beckoning. At the beginning of every year, my peers find it strange that I don’t believe in setting New Year’s resolutions.

I prefer to focus on creating sustainable habits rather than unrealistic goals where I don’t necessarily have control over the outcomes.

In his book, The 7 Habits of Highly Effective People, Stephen R. Covey writes that the first habit that translates to effectiveness is the habit to be proactive. We as individuals tend to play the “victim” in that we often want to blame something or someone else for our circumstances.

It’s the same for us as investors.

We often want to blame politics, poor returns, and ignorance when we can’t retire or when we lose money.

Don’t get me wrong, the points mentioned above cannot be ignored, but often cannot be controlled either.

We tend to focus on things that are out of our control, which then leads to a negative mindset and problems that escalate over time. When we do not have a strategy and process that is applied consistently, we react impulsively, which often leads to poor decisions.

Reactive vs proactive investing

Back to focusing on things that are not in our control. In the accompanying graph, we compare three strategies to further substantiate this point.

Suppose we invest R100 000 in each of the below strategies in 1995:

• In the first strategy, we invest in the top performing asset class from the previous year. This is reactive behaviour, which speaks to the assumption that history will keep repeating itself in a predictable manner.
• The second strategy is the opposite of the first. It invests in the asset class that performed the worst during the previous year, with the hope that the asset class will recover from the low point it has reached. Although the foundation is different, the strategy is still largely reactive.
• The third strategy follows a strategic asset allocation approach, where a recipe is consistently followed over time, which will deliver a specific outcome with regards to returns in relation to inflation. The weights in the asset classes are rebalanced each year to their original weights consisting of 25% foreign shares, 10% foreign property, 25% South African shares, 10% South African property and 30% South African bonds. This is a proactive strategy.

It is clear that you do not need to be able to predict the future to be able to achieve reasonable returns from a well-balanced and diversified portfolio.

The first and second strategies result in current portfolio values ​​of roughly R1.1 million and R1.4 million, while the third strategy yields almost double the value (around R2.7 million).

Reactive investors make decisions based on impulse, while proactive investors make decisions based on principles (strategic asset allocation).

Focus on what you can control

As an investor, it is important to focus on what you can control.

Tax:  Although it is important to contribute to a pension fund/annuity before retirement so that you can deduct it for tax purposes, it is just as important to contribute to other investment vehicles (voluntary investments).

In this way, you can supplement your income after retirement from your voluntary investments, so that you do not have to withdraw your full income from your pension and pay unnecessary amounts of tax after retirement.

How you earn your income after retirement – in other words from which sources – can make a considerable difference on the tax drag on your investments.

Herewith a quick example from a recent client case-study.

He withdrew R112 000 per month from his living annuity of which R36 000 was deducted for income tax which left him with R76 000 in his pocket.

By withdrawing only the minimum compulsory income (of 2.5%) from his living annuity, and the balance from his discretionary investments (which he luckily provided for), he pays only R3 200 per month in income tax (that is 91% less).

A saving of R33 000 per month over the next 29 years (if we assume a life expectancy of 95) is equal to a total saving of R25.8 million (or R6.3 million in today’s terms).

By investing growth assets in a trust early on ensures that your wealth grows outside of your estate, saving your heirs 20% to 25% in estate duty in the event of your death.

Fees: Avoid advisers and investments that charge high upfront fees unnecessarily.

Also stay clear of investment platforms with hidden or high administration fees.  Pure investment platforms are often the better option.

Do not try to “diversify” by investing on different platforms, since that is not where concentration risk lies.

By consolidating all your investments on one platform holds scale benefits and can reduce your administrative fees considerably.

Composition of investments: Strategically choose an asset allocation that would allow you to meet your return expectations over the long term. For example, you will not be able to beat long term inflation by five percentage points if you only have 30% to 40% exposure to growth assets.

Your method therefore needs to be fit for purpose.

It is particularly important to ensure that your portfolio is rebalanced regularly (at least annually) to the original weightings.

Investor behaviour: Make sure that you do not sabotage your chances of achieving a good outcome by succumbing to fear or greed by changing your portfolio based on what you hope, or fear might happen in the short term.

In conclusion: Do what you can to optimise the aspects of your investments that you can control, invest the necessary time and energy to apply sensible asset allocation to your portfolio, and simply trust the process.

Deidre Valentine is a certified financial planner and wealth manager at Woodland Wealth (formerly ProVérte Wealth & Risk Management). Contact her at info@woodlandwealth.co.za.

Although all possible care has been taken in the preparation of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone who intends to take any financial action based on this document is strongly advised to first consult with his/her personal financial advisor. Woodland Wealth is an authorized financial service provider with FSP no. 5966.