“The biggest destroyer of Capital is inflation.” So says investment expert Dave Foord in his book Time in the Markets. As investors we need to be vigilant about inflation and combat the annual erosion of our capital by investing in income-earning assets – but is your portfolio geared toward beating inflation?
In any good investment portfolio, annual growth should exceed inflation after costs have been paid. The reason for this is quite simple – since inflation decreases the value of your money by a certain percentage each year, an investment that fails to beat inflation will actually result in your capital being worth less and less as time goes by.
Historically, equities have outperformed inflation by an average of 8% per year, with economists predicting that this figure will drop slightly to 6% above inflation, in years to come. Whatever the exact figure, it should be clear that in order to beat inflation you need to be actively investing in equities – especially in the current climate of low interest rates that are making cash particularly unattractive as an investment.
Investing in Equities – Avoiding the Pitfalls of Speculation
As an equities investor, it’s crucial that you understand the difference between investment and speculation. While investing involves buying certain shares, or a managed fund like a Unit Trust, with a long-term view of accumulating capital, speculation involves the risky practice of buying and selling shares rapidly in the hope of “striking it lucky” and making a fortune on the stock market.
In a sense, speculation could be compared to gambling your money since the chances of making large losses are significantly higher with this strategy.
Research has shown that 80% of gains are made on 2% of trading days over the long term, making it very unlikely that speculation will give you the returns you require over time. A balanced portfolio and a long-term investment approach are the keys to capital accumulation, since being in the market for longer allows you to withstand its highs and lows.
Dave Foord on the Markets
According to Dave Foord, market levels are determined by four factors. You should bear these factors in mind when making your investment choices:
1. Profits – When profits are high across different sectors of the economy, money is available for investment and reinvestment. At these times, shares tend to rally.
2. Interest Rates – Because investments compete with each other on yield comparisons, interest rates are an important factor. For example, the current low interest rates may favour equities over cash
3. Confidence – Positive economic and political news always bodes well for the markets, while bad news makes investors uneasy and may result in sell-offs. A positive outlook is always excellent for any market.
4. Returns – The rental earned from property, dividends earned from shares, and the coupon rate on government bonds are all examples of returns. Higher returns make certain types of investment more attractive than others, provided that the risk of investing is reasonable.
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