Investing and trading

Taking stock

Before investing in a share portfolio, ensure your financial house is in order to avoid being forced to sell during market downturns, by having an emergency fund (three to six months of essential living expenses in a liquid, low-risk account). Next, set your goals. Define whether you are investing for long-term wealth (for example, retirement) or shorter-term needs (for example, a home deposit) as this will, in part, dictate your risk tolerance.

Now that you’re ready to start investing in shares, ensure that you are comfortable with the amount of market risk you will face. At this point, it is worthwhile to decide on your share allocation, as this will impact the extent of market risk or volatility in your overall portfolio.

The percentage of your portfolio in shares depends on your age, risk tolerance and goals, but common, evidence-based recommendations range from 50% to 100% for growth-focused investors, typically guided by the ‘100 minus age’ rule, with younger investors holding more in shares. A 30-year-old might hold 70% to 80% in shares, while someone closer to retirement may hold 40% to 60% for better stability.

General guidelines for share allocation:

Aggressive (long-term growth, high risk tolerance): 80% to 100% in shares.
Moderate (balanced growth/stability): 60% to 70% in shares.
Conservative (income focus, low risk tolerance): 50% or less in shares.

First steps

Now that you’ve decided that investing in shares will ensure that you meet your long-term investment goals, you need to weigh up the risks to determine whether you can tolerate them for the potential benefit of long-term returns. Understanding market risk in general and the effects of volatility on portfolio returns is a crucial first step. While closely related, market risk and volatility are not the same.

Volatility measures the speed and intensity of asset price fluctuations (up or down), while market risk refers to the broader potential for permanent loss of capital due to market movements. High volatility doesn’t always mean high risk, as an asset may recover. Indeed, volatility can be advantageous, as investors can use it to improve returns by shifting from a mindset of fearing market fluctuations to one of leveraging them as opportunities for buying lower, selling higher, and generating income. Volatility – often measured by the VIX or standard deviation – creates price opportunities that, when managed with a disciplined, long-term approach, can enhance overall portfolio performance.

Diversification considerations at different stages of the retirement savings timeline

The general guidelines for investing in shares can be linked to your age, with aggressive, moderate or conservative exposure to shares determined by how far away you are from retirement.

Here are the key diversification considerations at different stages of the retirement timeline:

Early career (20s to early 30s): Aggressive growth

Capital appreciation and compounding.
Diversification strategy: High exposure to growth assets (shares).
Considerations: With a 30- to 40-year horizon, you can withstand short-term market volatility to achieve higher long-term returns.
Asset allocation: Portfolios may be 80% to 100% in equities.

Mid-life (30s to 40s): Balancing risk and growth

Balancing increasing financial responsibilities like debt and family responsibilities with long-term growth.
Diversification strategy: Begin introducing a blend of assets to balance risk and safety.
Considerations: While growth is still critical, you may start to reduce exposure to highly volatile sectors.
Asset allocation: A more balanced approach between growth assets (equities) and defensive assets.

Pre-retirement (50s to early 60s): Capital protection

Protecting accumulated wealth.
Diversification strategy: Reducing risk by decreasing equity exposure and increasing exposure to defensive assets.
Considerations: This is often the period of maximum portfolio value – it is harder to recover from a 30% drop now than it was in your 30s.
Asset allocation: Often a 50/50 or 60/40 split between equities and bonds.

Retirement (60s and beyond): Income and sustainability

Generating steady, reliable income (liquidity) while ensuring the portfolio lasts for 20 to 40 years.
Diversification strategy: Heavily weighted towards income-generating assets but maintaining enough equity (30% to 50%) to outpace inflation.
Considerations: Longevity risk (outliving money) requires continued, though lower, exposure to growth assets.
Asset allocation: Diversifying 40% to 60% of your portfolio into offshore assets is recommended to manage country-specific risks, such as currency weakening.

Common mistakes and how to avoid them

Emotional decision-making: Understand your risk appetite upfront. Research the companies you want to invest in and leverage market dips as opportunities to increase your exposure.
Lack of diversification: Spread your investments across sectors and geographies to reduce portfolio volatility and avoid overexposure to any single sector.
Trying to time the market: Invest regularly to benefit from rand cost averaging. Different entry levels are smoothed out over time – assuming you invest in solid companies that deliver consistent long-term returns, including dividends.
Investing funds you may need soon: This can put you in a position where you need to disinvest prematurely, and potentially at a loss.

The role of cash in a share portfolio

Maintaining a constant allocation of cash, cash equivalents, or highly liquid, low-risk securities (like money market funds) in your share portfolio is often referred to as keeping some ‘powder dry’. These intentionally uninvested funds, readily available as capital, act as a ‘war chest’ to take advantage of market downturns, buy stocks at lower prices, or cover unexpected costs as they arise. However, be sure not to have too high an allocation to cash as this can create a ‘cash drag’, with overall portfolio returns being lowered due to the low income earned on cash, as well as missed market opportunities that could have delivered superior returns.