Building your portfolio
The right investment portfolio for you relies on an understanding of the various asset classes and how to combine them effectively. These assets include equities (shares), bonds, cash, property and offshore exposure. Each asset class provides a distinct return in different economic environments and is associated with a unique level of risk.
By diversifying across these assets, you can manage risk and enhance potential returns. The charts below provide a basic illustration of a diversified asset allocation for a portfolio that has a moderate (medium) level of risk.
As seen in the example above, the portfolio is invested 60% in shares, 25% in bonds, 5% in cash, 5% in property, and 5% in other assets. 25% of the total portfolio is invested offshore into a combination of these asset classes, with 75% being invested locally.
Let’s consider each asset’s risk/reward profile:
Understanding Each Asset
Growth Asset Classes
Equities (Shares / Stocks): Equities, represent ownership in a company. When you buy a share, you become a part owner of that company and can benefit from its growth and profits.
Shares have historically provided the best returns, and when managed correctly, can vastly outperform inflation. Over the past 40 years, the Johannesburg Stock Exchange (JSE) has delivered an average nominal return of around 15% per annum – that is the equivalent of doubling your money every 5 years. This is a whopping 7% per annum above inflation. However, equities are known to be volatile, historically ranging in fluctuations from -26% (in 2008) to over 61% (in 1999) in a single year.
Property: Property investments held by unit trusts typically include listed real estate companies and Real Estate Investment Trusts (REITs).
Over the past four decades, property has provided nominal returns of approximately 12% per annum, with real returns around 5% per annum. Property values can fluctuate significantly from changing economic conditions, with previous annual fluctuations ranging between -20% (2008) and + 65% (2021).
Other assets: Some other specialist assets that may be included in your portfolio are commodities such as gold and platinum, hedged equities which include protection against market fluctuations, infrastructure project investments and private equity funds, which can all provide high returns, but with considerable risk.
Stable Asset Classes
Bonds: Investing in bonds involves lending money to a company, a government, or a combination of both. In return, these organisations promise to pay back your loan at the end of the term while providing interest payments over the agreed term.
Bonds are generally assumed to be less risky than shares and can, at times, achieve ‘equity-like returns’ as they did in 1998 when they achieved returns over 20%. The worst performing year was as recent as 2022, with returns of only 0.5%.
South African government bonds have historically offered nominal returns of about 10% per annum. In real terms, this translates to around 3-4% per annum. While bonds are less volatile than equities, they can still experience price changes, particularly in response to sharp interest rate movements.
Cash: Investing in cash, such as money market accounts or bank deposits, is considered one of the safest forms of investment. These investments are not affected by the stock market but typically provide the lowest returns over the long term. Cash investment returns are primarily influenced by interest rates, such as the bank repo rate.
Over the past 40 years, the average nominal return on cash in South Africa has been around 8% per annum. However, when adjusted for inflation, the real return has averaged approximately 1% per annum. Cash returns are the most predictable over the short-term, with the lowest one-year return being just 4.8% in 2020.
Offshore Assets: The Rand’s value can be highly volatile, influenced by factors such as political stability, economic performance, and global market trends.
Over the past 40 years, the Rand has depreciated against the US Dollar by 4% per annum, but has experienced extreme fluctuations, down over 58% (2001) and appreciating by over 20% (2020-2021).
When investing offshore, there is a broad universe of different equity and bond markets. The returns you achieve in these markets will be combined with any Rand returns you achieve, either enhancing or diminishing your returns.
Asset Allocation and Risk
The riskier the assets you have in your portfolio, the higher your potential returns. However, as we have seen, these assets are more volatile and require a long-term investment horizon.
Understanding the level of volatility each asset can experience allows you to tailor your portfolio based on your investment timeframe. Investing for a short period requires less risk, while a longer-term investment allows for a greater tolerance for risk.
The diagram below provides a helpful guide on the relationship between levels of risk, your investment horizon and how much of your portfolio should be invested in risky assets and offshore assets.
The chart below provides an illustration of the range of returns you can experience in a portfolio with moderate risk as per the asset allocation example further above. The grey bars illustrate the average return range, whereas the dark blue bars, show the possibility of extreme returns. The average return range narrows over time as fluctuations are spread out.
Although this portfolio can provide returns exceeding 15% p.a. in the first 1 to 3 years of investing, returns can also be negative in extreme cases. It is therefore recommended to match this level of risk with a 5 year+ investment horizon.
Please note, that these charts should be seen as guides and not as hard and fast rules.
Reviewing Your Overall Asset Allocation and Risk
It is essential to understand how your investments are allocated across different asset classes to ensure they are aligned with your personal investment goals. It is important to note that your personal risk tolerance – how much risk you can tolerate – needs to be overlayed.
Regularly reviewing your asset allocation and adjusting it according to your risk needs and financial goals is crucial for long-term success.
