How does compounding interest work? Should you be investing offshore or on the JSE? What exactly is a “long-term” investment? In this episode, the first in season one of our Unpacking Wealth Creation podcast series, Investec Wealth & Investment Portfolio Manager Stephen Silcock and Wealth Manager Tebello Rabele answer these questions and more.

How did your interest in investing start?

Stephen Silcock says: “I inherited some of my passion for investing from my grandfather, who was very well respected in stockbroking circles around South Africa. Some of my fondest memories are of sitting with him in his mahogany-lined office, listening as he spoke about shares and why you must start investing young. “My grandfather used to talk about Leo Tolstoy’s quote on the two most powerful warriors being patience and time. He had a very long-term view on investing.” 

Tebello Rabele’s interest also stems from childhood. “I developed a passion for investing at a young age – I come from a family of entrepreneurs and businesspeople. My father used to put the newspaper in front me and make me read through all the stock prices, which sparked my interest in pricing businesses,” he says.

You both started investing early. Why is this important?

Stephen and Tebello agree it’s all down to reaping the benefits of compounding interest. “Compound interest favours those who start early in life, but it’s never too late or too early to begin. Time is magic when it comes to compounding,” says Stephen.  

Tebello points out: “We all know there are lots of competing interests for your money when you’re young, but the impact of compounding is really powerful. Studies show that the longer you invest for, the more you benefit from compounding.”

Compounding interest is best explained by using an example: If you put away R100 for five years at an interest rate of 10% per year, you will earn R10 a year in interest in the first year. If you reinvest that R10, the total amount that will earn interest in the second year becomes R110, 10% of which is R11. If you reinvest that, you’ll start off with R121 at the start of the third year and so on, as per second and third columns in the table below. The fourth and fifth columns show what you’d earn if you pocketed your interest every year (rather than reinvesting it to compound).

At the end of the five-year period, you’ll have earned R61.05 in total on that initial R100 if you allowed your interest to compound. By contrast, if you’d rather pocketed the R10 every year, you’d only have earned R50 (R10 a year for five years).

This is a simple example over a relatively short time horizon - the effects get more powerful the longer the interest is left to compound.

But you can’t guarantee your investment will go up every year so what about the inevitable market falls?  

There’s absolutely no way to know how your investment will perform – that’s the risk you take with investing. While you hope it goes up, there are likely to be unavoidable periods when it won’t perform that well and hard as it may be, often the best course of action is to not take any action at all.  

Stephen says: “I know it’s going to sound very boring, but during stomach-churning events like bear markets, the best thing is actually to do nothing, and to allow compounding and time to do their work. The problem is that these sorts of environments are highly emotive. My grandfather remained very dispassionate about all the emotionally-charged things that were happening day-to-day and this ultimately resulted in him coming out ahead on his investments.” 

Tebello points out that it’s hard to know when the right time is to enter the markets. “Time in the market versus timing the market is a very crucial aspect of investing,” he says. He means that it’s advisable to stay invested for the long-term rather than try to predict when the best time to enter the market is. 

What about just staying in cash in order to avoid the ups and downs of stock markets altogether? 

Stephen is adamant that this is a poor strategy. “I’ve been reading about how the younger generations dislike shares, especially compared to cash. I can understand that people who started investing 20 years ago have experienced the Dotcom crash, the Great Financial Crisis and then obviously the pandemic more recently. So, you’ve had some big drawdowns in markets over that time and it’s made people fearful of markets such that they have stayed in cash and I think that’s very risky. Being in cash is dangerous. Research suggests it’s been the worst performing market over time and that shares have performed best over longer periods.”

Can you share an example of long-term investing?

Stephen demonstrates the benefits of long-term investing with a real-life illustration.  “Everyone knows Apple – most households have some sort of Apple device these days,” he says. “Apple listed on the stock market in 1980 and if you’d invested then, and stayed invested until today, you would have made an accumulative return of over 56,000%!”

But, he adds, it wouldn’t have been plain sailing. “During your investment term, you’d have had to stomach share price falls of over 80% on two occasions, over 60% on two occasions, and over 50% on many occasions. Panicking in these pullbacks would have been exactly the wrong thing to do. What you need to do is understand that companies can go through downturns but as long as the company has good management, with moat-like defences in the form of pricing power, you should probably stay invested.

“Don’t be impatient with your investments – don’t expect them to perform too quicky. The best return is usually slow and steady,” he says.

On the topic of risk, how should we be thinking about it in the context of investing?

Stephen explains that we tend to think of risk as a fixed concept – in other words, that shares are riskier than cash and bonds. But we also need to assess risk in combination with time horizon. He says: “If you’re 25 you probably have a 40-year time horizon until retirement, you can then have quite a lot of exposure to shares because you have time to ride through the ups and downs of the stock market. “Changes in lifestyle and medicine means that we’re living longer and retiring later, so even that 40-year view looks quite conservative to me. So, avoid making decisions as though you’re on the verge of retirement when you’re young. It could cost you huge amounts of wealth.”

Tebello expands: “Look at what’s happened in SA over the last 45 years – shares have given you an annual return of about 19.6%. Inflation has been about 8.5% so you’ve had a real return of about 10.5% over that time. Cash returned about 10%, so your real return would only have been around 2%.”

One way to manage risk in your portfolio is to diversify. What does this mean and how does it work?

“I think one of the most important decisions you make as an investor is the allocation between asset classes such as shares, bonds, property and cash,” says Stephen. These asset classes tend to do well at different times because they are not correlated to each other. For example, it’s often the case that shares do well when the economy is growing but bonds often outperform shares when the economy is slowing. By holding both shares and bonds, you can spread out your risk of loss.

Tebello points out the benefits of diversifying by geography. He says: “Geographic diversification is crucial. Remember that SA’s listed markets constitute less than 0.5% of global listed markets. Investing 100% of your assets in SA means you’ve got less than 0.5% exposure to global markets.” Having some of your money invested in non-South African assets, especially assets that are not correlated to the SA market, means that you can potentially protect your portfolio when the SA market is doing badly. 

So should we be investing offshore rather than on the JSE?

Offshore investing can be a good way to diversify your geographic exposure but it really depends on your individual circumstances and what you’re looking to achieve with your money. It can be a daunting task as there’s an overwhelming amount of choice and information. Finding an investment partner with expertise and a global presence is important as they will have insight into all the different factors driving different markets globally.

Tebello warns that offshore investing can have unfavourable tax ramifications though. “Something that people often neglect to think about when investing offshore is that the tax implications upon death may be quite detrimental to intergenerational wealth transfer,” he says. “While we are seeing a lot of high net worth individuals taking a large portion of their assets offshore, that doesn’t mean you can’t make money in South Africa. We think that South Africa and emerging markets look very attractive at the moment.”

Stephen agrees that from a valuation perspective South Africa and other emerging markets look cheap, especially compared to the US.

What are the first steps investors should be taking on the investing journey?

Tebello advises clearing your debt first and increasing your capacity to earn. “Invest in a new skill, get a mentor and set some goals,” he says. He adds that it’s important to take the advice of professionals. 

Stephen agrees and thinks it’s important to find someone with experience and whom you trust to manage your wealth. What you really need, according to him, is a ‘sleep easy’ portfolio – one that doesn’t keep you up at night. “I wouldn’t be taking on any additional risk that causes you to not sleep well at night. You have to ensure the decision you make rests very easy on your own shoulders and those of your adviser,” he concludes.