Achieving Financial Freedom

For all of us financial freedom seems an insurmountable challenge.
How can I ever become free of the things that I need that I have to fund
with large loans – such as a home, a car and an education. Add to this
the high general cost of living and it seems that financial freedom will
never be possible. A few practical steps will possibly assist with this
journey.

It seems like a cliché but you must save.

The general recommendation is that a minimum of 10% of your take home
pay must end up in a place where you cannot spend it. This is even if
you owe other people money. A study has shown that people that save 30%
of their income are more likely to become multi-millionaires. If we take
the simple case of someone that earns R 7000 and 10% of their incomes
gets saved at 5% annually. This leads to a nice R 47,000 after 5 years.
What has been found however is that people that have this discipline
tends to save more and in time get higher returns as they become more
aware of expenditure and investment options.

Once you start putting money towards a goal then you start to build
up capital. An important principle here is that capital should never be
its own master – it must always have a purpose. If you are clear on the
purpose that you need money for – it becomes a lot easier to justify the
sacrifices that you are making towards that purpose.

As your money starts accumulating you will be able to start
investing.

There is a model that says that you need to diversify your risk and
start building a portfolio of investments.

Please always speak to a financial advisor as the below is not
financial advice – but rather serves as a guideline for having a
conversation with your financial advisor. A financial advisor may have
the necessary training to analyse your needs – but information is
provided to outline some directions for your thinking.

Cash

Cash is a good investment but the problem is inflation and tax. Make
sure that if you invest in cash through e.g. money market accounts that
you get good interest rates, low fees and that your investment is
protected.

Positive

• Usually the contribution that you make – i.e. the capital is
  guaranteed.

• Cash is very easy to draw. If you lose your job and need some food
  or rent, your cash reserves can quickly be converted to satisfy whatever
  need is at hand. Savings can be converted to cash in hand fairly
  easy.

Bad

• Cash becomes less valuable over time. So you interest rate needs to
  be higher than the inflation rate.

• Historically, cash has earned the lowest returns of the major asset
  classes.

Risk/Reward trade-off

• Risk = Low

• Reward = Low

How to invest

• Open a savings account

• Overpay on your credit card (build a positive balance)

• Open a money market account (usually requires a minimum
  balance)

Time horizon

Cash is useful over any time frame, but you are likely to get poor
slowly if you hold excessive amounts over the long term. You need more
interesting investment options to achieve most financial goals.

Bonds

Government retail bonds are tools that pay you a regular income
according to a coupon rate. By investing your money with the government
through bonds you create the opportunity to earn a stable income as the
conventional wisdom is that governments do not default on their
bonds.

Good

• Government bonds are much less volatile than equities.

• Historically, they’ve provided a better return than cash.

• A lack of correlation with equities makes government bonds a useful
  way to protect yourself against stock market crashes.

Bad

• Bond returns historically lag equities.

• They are vulnerable to inflation (unless you choose index-linked
  varieties) and changes in interest rates.

• Many investors struggle to understand bonds.

Risk/Reward trade-off

• Risk = Lower than equities, higher than cash

• Reward = Lower than equities, higher than cash

Time horizon You can match your bond holdings to any
time horizon and know exactly what your return will be, if you hold the
bonds until maturity. You may have to lock up your money for 1, 2 or 3
years to get good returns.

How to invest

• In South Africa you can visit www.rsaretailbonds.gov.za or
  speak to a financial advisor on options to invest in bonds.

• Most banks also have information on investing in bonds.

Shares

Shares (commonly known as equity or shares) are historically
the riskiest and best rewarded of our main asset
classes.

Because equities can go up and down, investors demand high potential
rewards to play the game. Note that word: potential. There is
no guarantee that equities will deliver; they do not provide a guarantee
of income or capital. Instead, they offer part-ownership of a company
and thus a claim on its future earnings.

Good

• Equities have traditionally outperformed every other asset class
  when it comes to long-term returns. They are the most powerful asset
  class in your diversified portfolio.

• Equities are capable of outstripping inflation.

• The longer you hold equities, the better your chance of achieving
  your financial goals.

Bad

• Severe losses can occur at any time and frequently do. You could
  easily lose 30% of your capital in a single year.

• Losses can be very long-lasting.

• The highs and lows of equity ownership can feed all kinds of
  irrational behaviour, from panic-selling in the face of loss to piling
  into a bubble market. Fear and greed rule.

Risk/Reward trade-off

• Risk = Higher than bonds, property or cash

• Reward = Higher than bonds, property or cash

Time horizon

The longer you can hold the better. Five years is the bare minimum,
20 years is a more comfortable stretch.

How to invest

• Get a stock broker

• Buy some stocks and sell them later – until you get an
  understanding of how this all works

Your own business

Even riskier than shares, but far more rewarding is starting your own
business. Investing in yourself and your ability to take an idea and
turn it into a mega empire is not for everyone – but those that do it
will testify that there is no better way to make money.

Good

• You are in control of your financial destiny

• Your dreams and passion can be expressed

• You create employment, financial freedom and growth

Bad

• There is significant personal and emotional risk attached to
  starting a business

Risk/Reward trade-off

• Risk = Higher than any other investment

• Reward = Higher than any other investment

Time horizon

Most businesses that survive reach initial maturity after 10 years
and start yielding exceptional returns only after 20 years.

How to do it

• Get a product

• Get a market

• Sell !

• Start employing others to do aspects of your business

• Market !

• Expand slowly according to what your customers want while
  sticking to your core business at all times.

Property

As an investment asset class, property (or real estate) refers to
commercial property that delivers returns in the shape of rent and the
appreciation of building values. It doesn’t refer to your
house.

Exposure to commercial property is generally achieved through
real-estate investment trusts (REITS) or ETFs. Sticking all your money
in a ‘buy-to-let’ concentrates rather than diversifies your
holdings.

Good

• Historically, the risk and rewards of property have been a halfway
  house between equities and bonds.

• It can be a useful diversifier, as global property returns have
  demonstrated a moderately low correlation to UK equity.

• Property is also likely to keep pace with the rate of
  inflation.

Bad

• Property bubbles can pop and inflict large losses on funds.

• Property is illiquid, which can lead to funds imposing exit
  restrictions on investors during periods of market stress. In other
  words, they can’t sell their buildings quickly if
  everyone wants their money back at the double.

• Investors tend to have a rose-tinted view of property due to the
  strength of the home market over the last 20 years. However the asset
  class has historically lagged equities.

Risk/Reward trade-off

• Risk = Higher than bonds or cash, but lower than equities

• Reward = Higher than bonds or cash, but lower than equities

Time horizon: 20 to 30 years.

For most of us these are some of the options. There is also a
potential to invest in

• Commodities

• Exchange Traded Funds

• Derivatives

• Foreign exchange

• And a million other financial products.

Please always work through the schemes that are proposed to you and
make sure that you are satisfied in your mind that you understand

• The cost of entering the investment

• The costs you incur while being part of the investment

• The cost of exiting the investment

• The return that is promised and the risk attached to
  that

• The return after costs

• The ability to exit an investment

• Always negotiate the rates

• Be careful not to borrow money at higher rates that you receive
  returns

There is no get rich quick scheme. You need to start by putting money
to work to make you more money. Hard work, focus and purpose will still
determine the winners and the people that will make the most of money in
the long term. To make investments work you need to spend time to
understand the different options that you have and take small steps to a
bigger picture. If you start working towards your financial freedom you
will achieve it.