Investment 101: How to build your investment portfolio

DISCLAIMER: I am NOT a certified financial adviser nor do I have qualifications in accounting. If you need professional help with your finances, consult with a certified professional in this regard.

Financial freedom and success does not criminate and is possible for any disciplined individual who is a great planner and has a desire to be financially intelligent. Whether you earn R5 000 or R46 000 per month, you can achieve Financial freedom by building an investment portfolio tailored to your goals.  

It is said that some people have financial freedom with assets of R5 million, while others who have assets of R50 million are not financially free. You can be certain that for those who have R50 million worth of assets and not financial free yet, the only missing piece of the puzzle is financial intelligence.

Financial intelligence is the absolute best foundation needed to build wealth. Knowledge, when applied correctly and at the right time, becomes not only power but profit.

No matter how much you earn, you can be financially free provided you understand key concepts required for building an investment portfolio. There are several key financial concepts and terms that are essential to understand prior to building a successful investment portfolio.

The most important ones include, Debts/Liabilities, Budgeting, Savings, Assets, Compound interest, Taxes, Risk Management, Diversification, Equity, Net worth, the list is extensive. For this class on Investing 101, here are the top two concepts you need to know;

1.    Saving vs Investing

Saving is the act of putting money away in the expectation of earning interest in the near future. It is a short-term strategy of building wealth, as opposed to investing which is long term. Savings account are liquid, meaning they can be easy to access your money in them.

Depending on your saving goal, savings account range from a 7-day notice flexible account to 6-month notice account. The longer the term of the account you choose; the more interest you earn. For instance, you will earn more on a 6 month fixed deposit account than on a 32 day flexi deposit account.

 On the other hand, Investing is the action of putting money into shares, property, or a business with the expectations of earning a profit over a long time (five years or more). Generally, the habit of investing your money into various classes of assets earns you more interest than just saving it but there is more risk involved. However, there are few techniques you can employ in order to manage and reduce the risks involved in investing. Diversification is one of them.

2.    Risk management.

Your goal should be to manage risk as much as possible. Sam Beckbessinger, in his book, Manage your money like a f*uking grown up says “the younger you are, the more risk you want. Diversification and long-time investment are two strategies that help you to manage and reduce the risk of losing your money which you invested.

Diversification is a strategy to help you manage investment risk in a variety of products to achieve higher long term returns at lower risk. It means spreading your funds across different asset classes to reduce the chance that all of the investments will drop in price at the same time.

Apparently, the majority of South African have share allocation ranging from 35% to 75%. If you are reasonably risk tolerant, require some capital growth and might need some income in the near future, your allocation should be 55% in shares, 25% in listed property/bonds and 20% in cash. If you aren’t very risk tolerant, rather consider a ratio of 35% in shares, 35% in listed property/bonds and 30% in cash.

It is said that long-term investors only get wealthy after 10 to 15 years of investing. If they invest wisely, the chances of blowing up on a long-term investment are much smaller, but traders (short-term investors) face this risk constantly.

Listed property and shares are an ideal combination for long-term capital growth. If you are relatively young with less responsibilities like myself, a good allocation would be 75% in shares and 25% in listed property. Or if you are looking for a combination of capital growth and income, you could reduce your allocation to shares, i.e. 50% in equities, 25% in property.

Any combination that you choose must ensure that your capital grows more than the inflation rate while generating a good income. Your primary goal investing your money safely with less risk is to beat inflation and the only sure way to win is to invest in growth assets that tracks or beat inflation like shares and listed property mostly.

Inflation (consumer price inflation) is a term for the general increase in prices. Over time, inflation can erode your purchase power. That is why it is important to invest in inflation beating investments. The table below shows long-term average growth of various asset classes after inflation.

Asset class	Indicators	Long-term average growth, after inflation
Residential property	ABSA House Price Index	1.9%b
Share market	All-Share Index	7.5%c
Listed property	SA Listed Propertyd	6.4%e
Bonds	All Bond Index	2.0%
Cash	Stefl Callf	1%

^aAnnualized, ^bSince 1966, ^cUpdated annually since 1900, ^dPrior to 2006 this was SA Real Estate Index, ^eSince 1983, ^fInterest-rate benchmark for large funds and companies.

Source: Warren Ingram, Becoming your own financial adviser.

Other terms you need to familiarize yourself with in your journey to building an investment portfolio include:

Net worth

Your net worth is the value of all your assets minus your liabilities at their current value. It helps you work out whether you are becoming richer or poor.

Interest

Interest is the fee the lender (e.g a bank) charges you for a loan or credit card. It can also be the return you earn on your savings in a saving account or assets you own like shares.

Shares

When the capital of a public company is listed on the stock market, the capital is divided into equal parts and sold. The holder of a share in then entitled to a proportion of the profits of the listed company.

Equity

Equity refers to shares that someone owns in a company. It could also be the increased value of a property above the amount you paid for it.

Dividend:

Dividend is a sum of money a company pays annually or every six months to its shareholders out of its profits and reserves. Not all companies pay dividends.

Shareholder

A shareholder is someone who owns a share (portion) of a company. Shareholder may attend annual general meetings and have some say in the company, depending on how many shares they own.

The definitions of the above terms are borrowed from Mapalo Makho’s Book, You’are Not Broke, You’re Pre-Rich. Good luck in your journey to financial freedom