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Investment Strategy 2010: If All is Chaos, What Then?

  01/12/10 08:21, by Len, Categories: Personal Financial Management, Investment Management

Source: Article by Felicity Duncan*

Twenty-ten won't be an easy year, but if you're sensible, it could still be a lucrative one. The trick, in so far as there is a trick, is to spot opportunities before the crowd does and to take advantage of them, all the while making sure that you aren't taking on more risk than you are comfortable with. Now, most people tend to focus on the first part of that instruction and spend their time looking for sexy opportunities, but the second part - controlling your risk - is probably more important, because the level of risk you are willing to take should be what ultimately drives your investment strategy. So let's take a moment to determine what you want to accomplish with your money this year, and how much can you afford to lose?

Remember, investing is all about maintaining a risk/reward balance that you're comfortable with. You're probably groaning at this lesson in fundamentals, but it's astonishing how many investors never really think about this issue.

It's an old truism that the higher the risk, the higher the potential reward. You'd expect a risky person - say your deadbeat gambling-addict aunt - to pay more interest on her borrowings than a safe person like your reliable primary school teacher mother. You might lend your mother R1 000 at 5% interest because you're pretty sure you'll get your R1 000 back. Your aunt, however, may have to offer you 20% interest to persuade you to lend her the R1 000, because you know there's a chance you won't see that money again. The same basic rule applies to anyone or anything else you might "lend" money to.

When you put your money into the bank, you're "lending" it money; that's why it pays you interest. However, it pays you relatively little interest, because it's pretty safe to have money in the bank, you can expect to get it back when you want it. Likewise, when you buy a South African government Retail Savings Bond, you're lending your money to the government, another very safe bet, and so you get some interest, but nothing that would shoot the lights out.

When you start lending to companies by buying their bonds, your interest earned ticks higher, because the risk increases (it's a lot more likely that a company will go bust than it is that a country will, except in the case of Greece). When you buy shares, you expect to get the highest possible returns (except in this case, dividends instead of interest) because there are no guarantees at all that you'll get your money back. In fact, if the company goes broke, you, the shareholder, will be at the back of the line when it's time to hand out the assets.

So when you're designing your 2010 investment strategy, ask yourself: is this a "lend to mom" year, or a "lend to Aunt Sue" year? In making that call, remember that another investment truism is "buy low, sell high", and the best time to buy low is when everyone else is too gloomy to shop at all, as is the case in times of recession like these. However, it's also true that 2010 is going to be a very uncertain year, and so this might not be the best time to sink your retirement fund into small caps.

In fact, given the uncertainty in South Africa and the world, it might be an idea to have a hybrid investment plan. You could put the bulk of your savings into something relatively safe that still delivers a decent return - inflation-linked government bonds are one idea, JSE blue chip unit trusts are another - and set aside a portion to invest in riskier assets. Decide what you are comfortable with losing, even if it's just R10 000, and put that money to work in riskier investments that could pay off handsomely, like mid-caps or even offshore emerging-market funds.

With that disclaimer in place, let's look briefly at where some opportunities could lie in 2010.

First, if the renewed global demand that many pundits are anticipating comes to pass, then resources stocks are a good bet. Industrial metals like platinum, copper and nickel are especially well-placed to benefit from upturns in demand, so keep an eye on good industrial metals companies, and if the price looks right, consider putting some of your money there. Inflation-hedges, gold in particular, remain a good choice given the unprecedented levels of government intervention and massive stimulus packages.

Second, although the World Cup-related opportunities in construction and real estate are behind us (unless you've found some wealthy Germans to rent your Bryanston home at some outrageous price come the football season), there are already savvy entrepreneurs planning ways to profit from all the new stadiums and other infrastructure post-2010. Start to look out for people and companies with good ideas or plans for using what we've developed for the World Cup, in terms of physical and technical infrastructure, next year and beyond.

Third, don't count consumer-linked stocks like retailers and financial services companies out for the year. Yes, 2009 was rough, and yes, it looks like 2010 won't be much better as consumer credit expansion remains anaemic and retail sales remain muted. However, these sectors could surprise on the upside. If the Reserve Bank gives in to pressure from the ANC's more leftist members, interest rates could fall further. Although this would be bad news in macroeconomic terms, and seems pretty unlikely, if it were to happen, retailers and financial services companies would enjoy a windfall that could pay off for shareholders (there is risk here, but potentially good rewards too). In addition, if the US dollar weakens in 2010 - a potential risk, given the massive monetary expansion of the last 24 months and the general weakness in the American economy - local consumers would see a boost in their buying power which could help retailers.

Remember, when you're making investment choices, your goal is to take on only as much risk as you are comfortable with, with an eye towards maximising your returns. Having the bulk of your savings safe might help you feel confident enough to take a calculated bet on something like interest rates falling. There's a big risk it won't happen, but if it does, there could be big rewards, and that's what makes markets.

* This article first appeared in Discovery Invest

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