Only the wisest and stupidest people never change. Confucius
They say the only constant in life is change. This is nowhere more apparent than in the world of investing where things change daily. How must the average investor cope with this kind of uncertainty?
Any rational thinking investor trying to manage their own money using the over-load of information freely available is likely to go crazy. This is probably why so many investors who take responsibility for their own finances prefer the perceived safety and control of a money market account.
Unfortunately cash has its own risk. I am not referring to splitting your investment between several banks to avoid bankruptcy, but rather the inflation risk of holding cash. Best illustrated using a cashflow analysis:
Investment: R 1000 000
Income required: R 60 000
Interest rate: 7%
Inflation rate: 5%
| year | Investment | interest | income | reinvested |
| 1 | 1000000 | 70000 | 60000 | 10000 |
| 2 | 1010000 | 70700 | 63000 | 7700 |
| 3 | 1017700 | 71239 | 66150 | 5089 |
| 4 | 1022789 | 71595 | 69458 | 2138 |
| 5 | 1024927 | 71745 | 72930 | -1186 |
| 6 | 1023741 | 71662 | 76577 | -4915 |
| 7 | 1018826 | 71318 | 80406 | -9088 |
| 8 | 1009738 | 70682 | 84426 | -13744 |
| 9 | 995994 | 69720 | 88647 | -18928 |
| 10 | 977066 | 68395 | 93080 | -24685 |
| 11 | 952381 | 66667 | 97734 | -31067 |
| 12 | 921314 | 64492 | 102620 | -38128 |
| 13 | 883186 | 61823 | 107751 | -45928 |
| 14 | 837257 | 58608 | 113139 | -54531 |
| 15 | 782726 | 54791 | 118796 | -64005 |
| 16 | 718721 | 50311 | 124736 | -74425 |
| 17 | 644296 | 45101 | 130972 | -85872 |
| 18 | 558425 | 39090 | 137521 | -98431 |
| 19 | 459993 | 32200 | 144397 | -112198 |
| 20 | 347796 | 24346 | 151617 | -127271 |
| 21 | 220524 | 15437 | 159198 | -143761 |
The above cashflow clearly illustrates the erosion of capital in order to provide for an inflation linked income.
The solution is quite simple. Either reduce the income required or invest more appropriately in some growth assets to generate a higher return. Make sure you are not saving yourself poor by avoiding risk.
Mark Williams
Mcomm, CFP®, HdipTax
T. 021-851 3746
E. service@synfin.co.za