The impact over a long period is enormous.

By Andró Griessel

25/11/2023

One point makes a big difference.

South African rugby supporters once again realised this in the recent Rugby World Cup tournament. We are unlikely to ever underestimate the power of one again.

One point, one second, one day, one hour, one person, or one voice can all steer the course of a game, race, a person’s life, or even that of an entire nation in a different direction.

The moment it happens, everyone is acutely aware of how small the difference can be and how close one came to a completely different outcome. When dealing with very small, incremental victories, deviations, or even setbacks over extended periods (years or even decades), we tend to look at the result at the end of such a period in awe of the difference between two seemingly comparable individuals, entities, teams, outcomes, and so forth, and then marvel at the gap that has emerged.

As an example: Tete Dijana won this year’s Comrades Marathon in a record time of 5:13:48. A tortoise (if it’s in a hurry) moves at an average speed of about 0.5 km/h. If the person who came in 17th place accelerated his pace with only twice the speed at which a tortoise moves, he could have beaten Dijana. Over short distances, the difference at 1 km/h is almost imperceptible, but over long distances, it makes a massive difference.

Investments or the building of passive wealth work no differently. After 20 years of working with this subject, I am still amazed at people’s disregard for the implications of this principle. Just like with most things in life, small, incremental differences in investment returns make an astronomical difference in the long term.

Consider a practical example of the importance of your investment’s incremental better performance compared to others over a long period. In the Internal Rate of Return table, observe the differences in returns between A, B, and C.
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The differences may hardly seem astronomical, yet A has delivered more than double what C would yield after almost 17 years and 36% more than B. The net return of the investment (represented by the red line on the graph) was a mere fraction less than VPI + 6% over almost 17 years.
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.If your advisor told you 17 years ago that your investments should beat inflation by 6% after costs in the long term, you would likely have happily completed the application form. As always, reality is much more unpredictable and challenging than theory.

See the specific investor’s experience (in red) over the 17 years in the accompanying table, Year-on-Year Returns. I included only full calendar year figures.
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• The average return per year over the first four years was -0.78%, while the inflation + 6% target was already at 12.29% per year.
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  Could you have maintained the course? Probably not.
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  In the subsequent five years, the average return was 19.15% per year, while the inflation + 6% target over the same period was 11.27% per year.
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• In four out of the 17 years (almost 25% of the time), you would have faced negative returns with the largest drop of 13.97% in 2008.
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  It is usually in these years that clients say, “I should have put my money in the bank.”
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• In six of the 17 years (more than a third of the time), you would have fared worse than what you would have earned (before tax) from a money market account.
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• While the long-term return was a decent 11%, the variation in returns on the investment was as much as 43.09% (from -13.97 to +29.12%).
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  Is there something to learn from this for you as an investor or for us who must try to help people stay on course?
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• All long-term projections require an average growth assumption but using a long-term average static measure like VPI + 6% to gauge performance year by year can be very detrimental to the investor’s psyche, as well as to his/her advisor.
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  We all want the investment version of the Dead Sea Marathon (the flattest marathon on earth), but unfortunately, the investment marathon is full of hills, but luckily also descents.
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• Only short-term money market investments (and Ponzi schemes before they go bust) provide consistent returns without declines. The larger the margin by which you try to beat inflation, the greater the “variation” in year-on-year returns you can expect.
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  The reward for accepting this discomfort should be evident when comparing A (long-term investment) and C (money market).
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• How you start is not how you finish. If, for example, you were unlucky enough to start investing at the beginning of 2008 or 2022, you likely had your baptism of fire early on, but it shouldn’t deter you.
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• Understand what your real return is and measure it against meaningful benchmarks in the short term.
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  An inflation-linked rate of return (such as inflation + 6%) is unfortunately not a meaningful short-term benchmark.
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  Sometimes, -5% is a good return, and sometimes, +15% is a bad return from a relative perspective.
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• When using an advisor or considering using one, spend as much time as possible at the beginning of the process to a) agree on a fair benchmark on a year-to-year basis, as well as b) what your long-term (ten years plus) inflation-adjusted return expectation is.
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  Your portfolio should then be managed in accordance with these guidelines.
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Finally

Always remember that success in investments, just like success in most aspects of life, requires enduring pain from time to time (psychologically) to reach your long-term goals.

Andró Griessel is a certified financial planner and managing director of Woodland Wealth. Contact him 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.