The podcast on this post is available HERE Pruning plants is a task most of us gardeners are very familiar with, especially at this time of the year. A good pruning leads to better fruit, and flowers in the next season. Pruning is often done during the growing period too – it’s called “pinching out”. You remove the first bud on the terminal stem to get the plant to grow new side shoots and give a better display/yield – so all the plant’s energy isn’t going into a single bloom – which can be destroyed by one hungry caterpillar overnight. Wealth portfolios aren’t much different… If you’ve read some of my posts, you’ll know that my wealth philosophy is that it be advice-led. The alternative to an advice-led portfolio is probably best described as either organic or adhoc, compliance driven. An organic portfolio is often a DIY portfolio that someone has built up over time, often with very little interference. The classic buy and hold strategy. Sometimes a broker will cobble together a portfolio, and not have the knowledge or inclination to rebalance (they should have used a single fund where at least the asset manger will do that for them). I work with my clients to set clear objectives for their wealth portfolios, and because every objective is going to dictate a different asset allocation (bonds/ cash/ stocks/ property/ offshore etc.) these need to be siloed off from each other. Great portfolios, great gardens or fruit farms rarely happen by accident. Orchards are usually made up of just one asset class – just one fruit, but ecology and glorious borders are all about biodiversity. Glorious borders are a flower bed carefully designed with a combination of flowering plants of different heights, colours, textures and timing much loved by serious gardeners. |
Nature has had thousands of years to perfect the science of balancing, but if you look closely there is still a chaotic mix of ever-changing variables – climate, season, pests, predators, alien interlopers and even just bad luck. Just like all the variables that go into gardening or farming, the asset allocation used in a portfolio is going to be dictated by the end objective – and this is where the advice-led plan comes in. This plan is not set in stone – wealth managers and farmers alike must learn to be vigilant and adapt. Portfolios will change according to fixed variables like time, yield required (if any), location (country) and they will also be influenced by changing variables like market conditions, interest rates, tax considerations, volatility, regulatory environment, super-cycles etc. Objectives evolve and change over your lifetime – simply because you will eventually run out of time to correct mistakes in your investments by ploughing back active income. When a fruit tree has reached maturity, it is usually too late to prune it to the shape you want. Moving it is possible but you’re going to lose yield in the process. Most of us are going to reach a time in our life where we want to switch from earning an active income to earning a passive income from our investments. This is not unlike a mango orchard. You’ll start off preparing the land, planting the saplings and tending to the trees as they grow and become old enough to produce fruit. Often, the first fruit must be cut off early because the fruit is too heavy for the thin branches and can break them (that’s what you have an achar recipe for). Eventually the orchard will produce a harvest, year after year for decades. That doesn’t happen by accident – nor will your wealth portfolio. When a farmer prunes a fruiting tree, they do it to balance out the tree, so that it will fruit all over – so that the tree doesn’t list because of the weight of the fruit. Pruning also ensures that the light gets at as many leaves as possible, and cutting dead or dying branches ensures that you don’t get die-back that effect healthy branches. If your wealth portfolio is allowed to grow unchecked, it too can become unbalanced and put your wealth at risk. One situation that we often see is ‘asset concentration’ – when one share is allowed to grow over a long time so that it dominates the portfolio. This is the equivalent to the heavy mango that breaks the branch (ask anyone who let their Steinhof shares dominate their portfolio). Pruning is not about killing the entire plant, nor is it about selling the entire portfolio, but it is about bringing a portfolio back into balance, taking profits from some areas, taking advantage of the annual capital gain allowance and investing in new growth points (new ideas). The South African stock exchange is well known for being top-heavy. Six companies (of around 400 listed) on the JSE have a market cap of 11.4bn, or 57% of the total market cap of the JSE. These are all multinationals (so have a natural rand hedge). The Nasdaq is also extremely top heavy – with the Magnificent 7 making up 41%. ETFs have been a wonderful way for individuals to get broad market exposure at low cost but be aware that if you invest in an ETF based on market cap (and not equally weighted) you are going to have this embedded share concentration – perhaps unwittingly. There are now thousands of ETFs catering to every sector, index, country, region, asset class and even niche ETFs that are a long way from the ‘passively managed’ moniker that initially made them so popular to begin with. In the US, 25% of new money being invested is going into ETFs – this ETF phenomenon is now so big that they move markets, not just follow them. If your portfolios are objective-orientated, then the ‘right’ balance will be easy to keep on track. Your advisor will monitor your asset allocation against this objective. This is especially important in your retirement pot, often the biggest slice of your wealth in your lifetime. This investment must be treated more prudently than other objectives – like leaving a legacy for example. (This prudent investment guideline is enforced by the Pensions Fund act regulations (RAs, Pensions, Provident funds) – called Regulation 28. These guidelines have changed quite considerably over time – you can have a 45% offshore exposure for example). If you DIY your investments pruning a portfolio can hurt. Who wants to sell down an asset that has given you great returns but is now exposing you to too much risk because it is overwhelming the balance? Then, where do you put the proceeds? I often suggest that you can reframe this decision for yourself to reduce this FOMO. In effect you’re locking in some of those profits. If the share is still good for more growth, then you just rebalance it back to a more manageable level – not sell it completely (and use the proceeds for new ideas that will take over when the share eventually reaches its maturity (they all do, eventually). If the investment is surplus to your needs – your retirement and other objectives are sorted – then by all means let it go wild. Win or lose it isn’t going to affect your lifestyle or retirement. There are so many moving parts involved in keeping a wealth portfolio in balance – it’s one of the reasons I love this profession – but it is time-consuming and needs nerves of steel at times. To help our clients try and understand the markets and the economy better, we put out a free weekly newsletter which you’re welcome to join (email me at dawn@rexsolom.co.za) Just because there is an embedded capital gain that is going to result in capital gains tax, focus on the fact that it has made a GAIN (it could have been a loss) not the TAX. What we advisors often do when we must rebalance a portfolio is that we try and offset the gains with losses in the portfolio. Remember, in RSA there is a R40,000 annual allowance – which you lose if you don’t use! Delegating the responsibility of balancing a portfolio to your advisor can also dull the pain. In summary, you cannot prune a portfolio unless you have a plan and clear idea of its objective, timeline and corresponding asset allocation and how these need to change as the seasons of you life changes. Articles and Blogs: Should you change your investments with changing politics? NEW Taking a holistic view of your wealth Why do I need a financial advisor ? Costs Fees and Commissions The NHI and what to do about it New-Normal for Retirement? Locking-In Interest rates – The inflation story Situs – The Myths and Reality Tax Residency – New Rules new headaches Are retirement annuities dead A new look at retirement Offshore investing – an unpopular opinion Cobie Legrange and Dawn Ridler, Rexsolom Invest, Licensed FSP 45521. Email: cobie@rexsolom.co.za, dawn@rexsolom.co.za Website: rexsolom.co.za, wealthecology.co.za |