The term ‘unit trusts’ is used very broadly and generally, it is assumed that ‘unit trusts’ are all linked to the stock market and other volatile assets. Generally, it is also assumed that if the market crashes all unit trusts will follow suit. This is not true.
Unit trusts vary in structure and risk as wide as the diversity across all global and local assets. In short, a unit trust can be as safe and stable as a money market. It can also ramp up through different levels of risk and volatility all the way to as volatile and aggressive as the most aggressive global emerging market equity or tech stocks. In South Africa, there are more than 30 main and sub-categories for unit trusts. There are more than 1 700 unit trusts in the SA market. Globally this figure moves up to over 100 000. One must therefore be a bit more specific when referring to ‘your unit trusts’.
Assuming your unit trusts are aggressive unit trusts with high levels of volatility then I will comment as follows:
If you intend to spend all your funds that are currently invested in unit trusts over the next two years, then yes – move to a money market type investment (unit trusts also have money market funds).
At least then you know exactly how much money you will have available to spend. If you stay invested in growth-type unit trusts you have no idea how much or how little you will have available to spend in two years’ time.
If your investment horizon is long term (seven years or longer) disinvesting now will probably be the worst thing you can do.
The ‘unit trust’ market is definitely going to drop again – that is a guarantee. But it is going to move up again. That is also a guarantee. The problem is that we do not know when the next move will be and whether it is going to be up or down. No one knows, especially the person who advised you to transfer all your unit trusts now after multiple years of mediocre returns at best …
Moving out of investments that have incurred losses means that you eternalise your losses. That is not a good thing. Astute fund managers take advantage of market distortions during periods when assets reprice.
The best time to invest, especially on a regular monthly basis, is when markets are distorted and people are selling – as you are now considering doing. Your losses will turn into someone else’s future profit if you sell now.
By nature, some investments are more volatile than others. It is important that you understand and accept the volatility of your particular unit trusts.
It is also important to distinguish between risk and volatility. They have different meanings. Risk is when you incur a permanent financial loss or if you fail to achieve inflation-beating returns over a long period. Volatility is the up-and-down movements of investment values as asset prices adjust due to market conditions or investor behaviour.
If you do not understand and accept your investment’s growth patterns, then you will be better off keeping your money in cash-type investments. Getting in and out of investments due to concerns caused by rumours and unqualified comments will lead to financial ruin.
Instead of trying to time markets, rather spend time creating a proper financial plan and implement an investment strategy. A very simple solution is to adopt the ‘three-tier bucket system’ as outlined below.
Tier 1
Determine what your cash requirement will be over the next two years. In other words, how much money do you intend to spend over the next two years? This does not include monthly budget items like food, bonds and so on, but capital expenses like holidays, weddings, or a deposit on a house.
Keep these funds in cash in your bank, but preferably in a unit trust money market investment because they pay maximum interest from rand one.
Bank accounts pay interest on a tiered basis and start with minimal interest.
Tier 2
Establish what your capital requirement will be between two and five years. This can include an overseas vacation, a deposit for a house or a car and so on. Invest these funds, taking limited equity exposure (between 30% and 50% depending on the duration of the investment) and limit offshore exposure to around 40% maximum.
Tier 3
This is earmarked for long-term investing. Start with 50% equity exposure and increase the equity exposure as the term increases. For investments of seven years + maximum equity exposure can be taken (as long as your risk personality can handle the volatility). The same applies to offshore exposure. The longer your investment horizon the more offshore exposure you can take.
- The caveat to offshore exposure is that the more you intend to draw as income from a portfolio, the less offshore exposure you should take. Investors who live off the income of living annuities must be aware of this. Rand volatility causes havoc on the capital value of an investment when the rand strengthens and you have too much offshore exposure. See my article ‘The optimal offshore exposure in a living annuity‘.
In summary
Cash cannot beat inflation if taxes are taken into consideration. That is why cash must be kept for a particular expenditure purpose. Cash is not a growth asset even if you are getting 12.5% in a fixed deposit which becomes between 7.5% and 10% after tax. The main problem is that the purchasing power of your fixed deposit reduces with inflation over the period.
After five years in a fixed deposit, your purchasing power will reduce by between 20% and 30% depending on the prevailing inflation rate.
The only way to obtain and maintain meaningful inflation-beating long-term returns is to accept volatility and include equity and listed property in your portfolio with a healthy chunk of that exposed to global markets.
Hopefully the above will provide you with some guidance. It will be advisable to consult with a suitably qualified financial advisor to assist you with your decision and to create a meaningful financial plan.
Happy investing.