Every year, legendary investor Warren Buffett's annual letter to shareholders offers valuable investment advice. In his most recent letter, he reaffirms the importance of developing an appropriate long-term plan that investors should stick to.
According to Steven Nathan, CEO of 10X Investments, long-term savers must not be swayed by short-term (a period of up to three years) investment returns, both good and bad, especially when it comes to saving for retirement. "In the context of a 40 year savings and investment period, investors should expect different investment environments; some good, some bad and some indifferent. The order and length of these are uncertain, so making investment decisions based on these short-term market movements can present significant downside risks."
Nathan explains that expecting volatility is different from being able to predict and profit from volatility. "The opposite is actually true. Investors who chase past performance often destroy substantial long-term value and fail to meet their retirement goals." He says that it is not that difficult to construct an optimal investment portfolio in theory, "but in practice we are swayed by behavioural biases and bad investment advice."
Strategies for retirement
Nathan says that the solution to designing the optimal investment strategy for retirement has three components. "Investors need to create life-stage portfolios, minimise their fees and stick to their investment decisions, without trying to chase past performance." Building on the first component, Nathan explains that investors should invest according to their investment horizon. "This could be based on their retirement age if they expect to purchase a compulsory annuity at retirement, or life expectancy, if they invest in a living annuity.
"A high equity portfolio is expected to earn 1.5% per year more than a medium equity portfolio over the long term, or 3% per year more than a low equity fund - with lower risk over periods of five years or more," he adds. "The compound impact of these higher returns over an investing life-time is dramatic: each 1% increases your final pension by approximately 30%.
"The longer your time to retirement, the higher your allocation to shares (equity) should be - the asset class with the highest expected long-term return but with higher short-term variability in returns. But if you are near retirement - within five years or so - you should rather look to portfolios with lower share exposure and higher exposure to bonds and cash (lower risk assets)."
Investors need a sensible game plan to maximise their long-term investment returns, he adds. "The game plan must protect investors from their knowledge gap, which includes succumbing to underperforming fund managers and high fees. The plan must also be robust, as it needs to last 40 years, or even up to 70 years for those investing in a living annuity post-retirement."
It is critical that investors stick to their plan. "After the 2008 Global Financial Crisis, many people lost faith in the stock market when 'investment experts' forecast the end of capitalism and a return of the gold standard. Investors sold shares after they had halved in value and then missed out on the sharp recovery in share prices, now more than 50% above the pre-crisis level," says Nathan.
Why listening to market predictions is a waste of your time:
Buffett says that investors should be sceptical of people who claim they are able to predict the future in order to earn higher returns. "Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game. Because there is so much chatter about markets, the economy, etc., some investors believe it is important to listen to pundits - and, worse yet, important to consider acting upon their comments."
Buffett further warns that "forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important." Approximately 90% of South Africans do not accumulate enough savings to secure their retirement. "Consumers need to save at least 15% of their income diligently over a period of 40 years. Even as a diligent saver, however, you can still almost double your retirement income by optimising your investment portfolio and sticking to a sensible game plan," concludes Nathan.
- Steven Nathan: CEO of 10X Investments