What does South Africa’s grey listing mean for you?

To understand what a recession means for the stock market, it helps to understand exactly what a recession is.

There are a number of definitions but put most simply, it’s when there is a significant slowdown in a country’s economic activity over a period of time. Generally if there is a decline in a country’s Gross Domestic Product (GDP) for two consecutive quarters (two three-month periods) then the economy would be seen as being in recession.

The threat of a global recession is looming large because of “once-in-a-generation” factors such as the effects of the Covid pandemic and the war in Ukraine, and this has an impact on stock markets and investors across the world.

Tough times for consumers

A recession has a variety of negative effects that can be felt across society: increased unemployment as companies retrench workers; people spend less money on goods and services; companies cut down production as consumers buy fewer products and services; and wage levels come under pressure.

For the consumer, the cost of living can increase as prices of items like petrol and groceries increase. This leads to a reduction in their spending on discretionary (non-essential) items. Job losses can further affect consumers’ income levels, while it can become even harder to find employment as companies look to reduce their wage bill and cut down on new hires.

Profits under pressure

None of this is good news for the listed companies that trade on the stock market, or for those who have shares in these companies. Although the stock market is made up of individual companies that fulfil a wide variety of services and produce a variety of products, to a large degree the success of these companies is influenced by the broader economy.

If the economy is thriving, then companies (and their share prices) will tend to benefit. That means happy days for shareholders. And of course the inverse applies. If the broader economy is under pressure, or in a recession, then this will generally have a negative effect on listed companies, and their share prices.

All in all, a recession can be a scary time for investors, with wild swings in share prices, downward pressure on investments, and a distinct lack of stability and predictability.

So where does that leave you, the investor?

Take a long-term view

When you start investing, one of the most important factors to take into account is your investment timeline – in other words, how long you want to keep your money invested for. This can differ depending on what your investment goal is. For example, if you’re in your 30s and you are saving for retirement, then you’ll be investing with a long-term horizon. If you’d like to cash in your investment for a house in the next two years, then that would be considered a short-term investment horizon.

During a recession, when investments have generally reduced in value, it helps if you have a longer-term horizon and don’t rush to access your investment if you don’t need to. All markets go through cycles, and eventually a recession will run its course. Cashing in investments during a recession, or “at the bottom”, can be avoided if you are able to sit tight and stick out the downturn. Yes, it’s hard not to panic when you see the share price plummet, but panic doesn’t make for good investment decisions.

As American investment guru Warren Buffet says, “It won’t be the economy that does in the investor over a five, 10 or 20 period – in my view, it will be the investors themselves … if you look at the record of the 20^th Century you’d say ‘How could anyone have missed in owing equities?’ and yet we had all kinds of people wiped out … if you had just owned stocks straight through, didn’t leverage them, you would have had perfectly decent returns.”

Diversify

Ensuring you have a diversified portfolio – one that is spread between the different asset classes such as stocks, property, bonds and cash – is one of the cornerstones of sensible investing. This is because it spreads your risk so that when one asset isn’t performing, you’ll be cushioned by the performance of your other assets. During a recession, when there is an increasing amount of volatility, diversification can help protect your investments.

Invest with caution

And yes, a recession can even offer some opportunities for investors because there are likely to be some “cheap” stock buys on offer.

“While a recession can be a difficult time for investors who are seeing declining values across their portfolios, it can also represent an opportune time to pick up value stocks whose price has been adversely affected by the wider sentiment. For investors, this can mean buying shares in a company that holds good fundamental value such as earnings, sales and cash flows at a cheaper price with a longer-term view of that company’s share price increasing in the future,” says DMA’s Christopher Clarke.

“A good example of a sector that tends to remain healthy in a recession are consumer staples such as basic goods that support everyday living. Think companies like Tiger Brands or Walmart where their main form of business is the manufacturing a distribution of necessities like food. Other classic examples of sectors that do well in recessions are companies in the health care, energy and IT fields.”

But because no one knows exactly how the stock market is going to perform, or when the bottom of the market has been reached, investing under these circumstances should only be done if you’ve ticked a few boxes.

• Firstly, ensure that you have emergency savings in place that could get you through a few months. If you have extra cash left over after making this provision, then perhaps give the stock market a try.

• Again, invest with a long-term mindset. During a recession volatility is the name of the game, so don’t be surprised if your stock picks don’t behave the way you’d like. If you’re not expecting immediate returns then you’re likely to be better off.

How to invest when the rand is getting weaker

South Africans have become used to the rand’s volatility, but the past few months have been a crazy, white-knuckle ride for even the most experienced investors.

The reasons for the currency’s weakness against the dollar are varied – rising global inflation and concerns about a global recession are just two of them. Both these factors mean that investors have been buying dollars, which are seen as a safe haven, and selling emerging market currencies like the rand. And when there’s a sell-off in the rand, the value of the currency drops.

“It is likely that the rand will always be more volatile than developed market economies due to various risks associated with emerging markets. However, volatility is not always constant and tends to change through time,” says DMA’s Charlotte Van Tiddens.

The bottom line is that these ‘macro-economic’ factors behind the rand’s weakness are beyond the control of individual investors. But knowing that there’s nothing to be done about a falling rand doesn’t really help when you see your hard-earned cash losing its value against a super-strong dollar, and your investments starting to shrink in global terms.

The secret to staying one step ahead and securing some financial peace of mind lies in understanding what strategies can protect your investments; and using this knowledge this to your advantage so that you know how to invest when the rand is getting weaker.

Winners and losers

A weaker rand is going to positively or negatively affect local companies, which in turn will affect their share prices – and your investments. If you’re the kind of investor who buys shares in individual companies, bearing this in mind and asking the question, ‘Who stands to gain when the rand is weak?’  can be helpful when deciding which shares you want to invest in.

For some businesses a weak rand is good news, particularly if they are exporters. That’s because they receive dollars for the products that they sell, and so when the dollar price is high, they’ll receive more money in rand terms. But there’s always a downside, right? A weaker rand is generally not good for companies that import products. Because they have to buy products in dollars, they’ll be spending more rands when the dollar goes up and the rand goes down. Prices of their products get hiked, and consumers end up buying less of them. Not good for the bottom line or the share price.

Research shows that when the rand is weaker, as it is now, companies that offer communication services and consumer staples tend to be better off. On the other hand, companies that focus on real estate or those that depend on consumer discretionary spending (in other words, spending on non-essential items) tend to be worse off.

Take it offshore

The other critical component for a South African investor is to ensure that a portion of your portfolio is invested offshore – or not in your country of residence. This is exactly for the reason that because offshore investments are not rand-denominated, they are protected against the currency’s devaluation.

There are an increasing number of ways for South African investors to get offshore exposure.  You can literally move your money offshore by exchanging your rands for a foreign currency and in turn investing this foreign currency into offshore domiciled shares or funds. This can be very admin-intensive and involve factors like exchange controls or tax-clearance certificates etc.

A more straight-forward option can be to invest in local funds that provide offshore exposure. These would include unit trusts that have underlying investments in international companies, or locally listed feeder funds such as the array of ETFs that one can buy on the JSE that track an offshore basket or index. What’s great about these ETFs and feeder funds is that they don’t require large initial investment amounts, so even if you only have a small amount of money you can still have access to investment opportunities.

It can also be comforting to know that even if you’re investing in big South African companies rather than taking your money offshore, you’re often likely to be protected against a weak rand. Many South African listed companies are “rand-hedged”, or protected against the ups and downs of the local currency.

“These companies generate the bulk of their revenue in foreign currencies like the dollar. Their expenses are not incurred in rand either. When the rand weakens and loses value, all else equal, their rand profit increases. Examples of rand hedges include the tobacco and luxury goods sectors and include stocks like British American Tobacco and Richemont,” says Van Tiddens.

Other examples of rand-hedge stocks are Aspen, BHP Billiton and Glencore.

Make sure you mix it up

As always, that classic investing mantra “Diversify Diversify Diversify” applies, and even more so when you’re wanting to invest when the rand is weak.

There are so many moving parts to the investment landscape, and unless you are a full-time investing expert it can be extremely complex to keep a handle on all the factors affecting the value of your investments. Bearing that in mind, one of the most important ways to protect the overall value of your investments is to make sure that they are diversified – in other words, exposed to a variety of asset classes, such as cash, equities (shares) and property so that you don’t have all your eggs in one basket.

This helps to spread the risk, and means that when one asset class is under pressure or under-performing, the other assets are not affected.

“Running up a down escalator.” That’s what legendary investor, Warren Buffet, had to say about inflation.

And it’s true.

Growing your hard-earned money in a saving account is difficult enough. The interest rates are low. And when you factor in inflation, it’s almost impossible. Did you know that South African inflation sits at around 5.9%? That is right at the top of the South African Reserve Bank’s monetary policy target inflation range of between 3 and 6%.

That means having your money in some of the best paying easy-access accounts and even some fixed deposit savings accounts. You’re actually losing money in real terms.

The culprit? Inflation, where prices go up, and purchasing power goes down.

Investing to beat inflation is a must-do to make sure your nest egg grows faster than the soaring cost of living.

Let’s look at investing to beat inflation

Anyone can invest, even if you start with a few rands. Now, while it’s always best to get help from the experts, you don’t need a financial adviser. It’s a riskier approach, especially if you are a novice investor, so using the services of a financial advisor should be your first port of call.

On the other hand, you can use one of many online investment platforms. In this case, it’s probably best to choose a ready-made fund where you select your preferred level of risk. The platform then offers a selection of funds that suit your risk profile.

1. Diversify your investment.

On diversification, you should build a diverse portfolio, or ready-made diversified fund, with a mix of assets. These could include equities, property, bonds, and alternative investments such as gold, often seen as a safe haven that can maintain value in times of stock market turmoil. This means you won’t be overexposed to the ups and downs of assets, firms, or sectors.

2. Invest in gold.

Gold is the oldest hedge against inflation.

The shiny yellow metal has grown at an average annual gain of 9.48% over the 20 years between September 2001 and September 2021. Over the same period, inflation was much less, which means gold investors are sitting pretty with several percentage points above inflation.

3. Look for companies that can raise prices when inflation rises.

Find that business with a reputation for brilliance. Now compare it with one which has a reputation for bad economics. Which would you choose? Would you still choose the brilliant company if they put their prices up? Chances are, if you’re an intelligent investor, you will.

What this means to you and your battle against inflation is that you can invest in a business that can increase its prices without losing business. You have significant advantage during periods of high inflation because the company can now offset its increasing costs.

4. Invest in yourself.

One of the sure-fire ways of beating inflation? Invest in yourself and your own talent. This is one of the best ways to maintain your purchasing power over time and defeat inflation.

The best lawyer or accountant in town benefits from having paid for their education in  “old rands” but can now offer their services in “current rands.” That means they’re ahead of the curve, at least in investing to beat inflation

5. Keep some cash savings

Now, while we haven’t been kind to allow your money to sit in a current or easy-to-access savings account, it’s vital to do so. On that subject, you should ideally have 12 months of average income as “cash in hand”. Yes, interest rates are low compared to inflation, but if you’re faced with an emergency, like losing your job, and don’t have cash, you’re in a dilemma.

This is because ALL your money is now invested in the stock market. What if it’s a downturn? You’ll have to sell, which means losing money, and inflation wins.

The solution: find the highest-paying savings account to protect your money against inflation as much as possible.

6. Limit your wants.

This is a no-brainer. Worried about inflation and your rand simply being unable to go the distance? Cut back on the needless things in life, the stuff that can make you drown in consumer debt: the designer trainers, that overly expensive watch. Now, look at your bank account? You still have as much money as you had, giving you a considerable defence against the vicissitudes of life.

To sum up, whilst we have included practical day-to-day tips (like limiting your wants), we have also made the financial case of investing to beat inflation.

And again, that’s a no-brainer. Investing in a diversified portfolio over a more extended period is almost always several points ahead of inflation, and that’s where you want to be.

It is January 1986. It is four months after PW Botha’s Rubicon speech and South Africa is under a State of Emergency. A South African investor decides to take cash out of the country. The investor transfers his rand-based deposits into a US dollar bank account.

Would this have proved to be a wise decision?

Isn’t it obvious? The exchange rate for $1 was R2 in 1986, yesterday it was around R15.50. A significant devaluation! Furthermore, there were several times during this period in which the rand experienced a blowout (a meaningful weakening over a short period of time). These periods include:

1. 1998 – the Russian debt default
2. 2001 – the 9/11 attacks
3. 2008 – the great financial crisis (GFC)
4. 2015 – Nenegate
5. 2020 – the Covid crash

Investors might be surprised to learn that they would have been better off leaving their cash in rand rather than converting it to US dollars.

But how is this possible given what we highlighted above? The answer lies in the so-called “interest differential”, that is, the difference between the Rand interest rate and the US dollar interest rate.

South African interest rates were on balance significantly higher than US interest rates over this period. More accurately, the interest rate difference more than compensated investors for the currency depreciation. Too few of us factor in the much higher interest rates in South Africa, when considering whether to have cash deposits in rand or in hard currencies such as the US dollar.

However, it goes without saying that investors were not always better off leaving their cash in South Africa. For example, the rand was particularly strong during the commodity boom of the mid 2000’s and again after the GFC. Investors that took advantage of these periods of rand strength and converted rands into US dollars were handsomely rewarded.

Going forward, what are South African investors to do? Should they listen to the doomsday practitioners and rather have dollar exposure, or should they keep their rands?

At Corion, we believe that the answer to that question is not an exact science and applying the following sound investment principles is the appropriate starting point: 

• Ensure a diversified portfolio that is not overly exposed to a single risk factor.
• Having a portfolio that is fully exposure to a single currency, even the mighty US dollar is not prudent.
• Understand the volatility that offshore currency can have on your investments over the short term. If one cannot tolerate sharp fluctuations in the value of deposit- based investments due to the need for liability matching, it is arguably better to have a greater amount in the same currency as your liabilities.
• History gives us guidance. Whenever the rand was extremely strong, investors were better of using the opportunity to take deposits offshore and to be exposed to rand depreciation rather than earning a higher interest rate. However, the timing of this is exceptionally difficult and as they say, it is only hindsight that is a perfect science.

*Article written by Simon Du Plooy – head of strategic investment thinking at Corion Capital (an Authorised Financial Services Provider). Corion is driven by a desire to simplify the world of investing and manage a broad range.

It is January 1986. It is four months after PW Botha’s Rubicon speech and South Africa is under a State of Emergency. A South African investor decides to take cash out of the country. The investor transfers his rand-based deposits into a US dollar bank account.

Would this have proved to be a wise decision?

Isn’t it obvious? The exchange rate for $1 was R2 in 1986, yesterday it was around R15.50. A significant devaluation! Furthermore, there were several times during this period in which the rand experienced a blowout (a meaningful weakening over a short period of time). These periods include:

1. 1998 – the Russian debt default
2. 2001 – the 9/11 attacks
3. 2008 – the great financial crisis (GFC)
4. 2015 – Nenegate
5. 2020 – the Covid crash

Investors might be surprised to learn that they would have been better off leaving their cash in rand rather than converting it to US dollars.

But how is this possible given what we highlighted above? The answer lies in the so-called “interest differential”, that is, the difference between the Rand interest rate and the US dollar interest rate.

South African interest rates were on balance significantly higher than US interest rates over this period. More accurately, the interest rate difference more than compensated investors for the currency depreciation. Too few of us factor in the much higher interest rates in South Africa, when considering whether to have cash deposits in rand or in hard currencies such as the US dollar.

However, it goes without saying that investors were not always better off leaving their cash in South Africa. For example, the rand was particularly strong during the commodity boom of the mid 2000’s and again after the GFC. Investors that took advantage of these periods of rand strength and converted rands into US dollars were handsomely rewarded.

Going forward, what are South African investors to do? Should they listen to the doomsday practitioners and rather have dollar exposure, or should they keep their rands?

At Corion, we believe that the answer to that question is not an exact science and applying the following sound investment principles is the appropriate starting point: 

• Ensure a diversified portfolio that is not overly exposed to a single risk factor.
• Having a portfolio that is fully exposure to a single currency, even the mighty US dollar is not prudent.
• Understand the volatility that offshore currency can have on your investments over the short term. If one cannot tolerate sharp fluctuations in the value of deposit- based investments due to the need for liability matching, it is arguably better to have a greater amount in the same currency as your liabilities.
• History gives us guidance. Whenever the rand was extremely strong, investors were better of using the opportunity to take deposits offshore and to be exposed to rand depreciation rather than earning a higher interest rate. However, the timing of this is exceptionally difficult and as they say, it is only hindsight that is a perfect science.

*Article written by Simon Du Plooy – head of strategic investment thinking at Corion Capital (an Authorised Financial Services Provider). Corion is driven by a desire to simplify the world of investing and manage a broad range.

Profiting in the financial market. That’s the aim, whether you’re investing or trading. The two take different routes to arrive at this shared goal. In Investing vs Trading 101, investors seek solid returns over an extended period. So, they buy and hold. On the other hand, traders enter and exit positions over a shorter period, taking potentially higher and more frequent profits.

Let’s define the two in more detail.

Unless you’re a Wolf of Wall Street (or a Jackal on the JSC), and even then, the stock market is a complex place. So, you must understand the basics, let’s clear up any confusion.

1. What is investing?

Investing’s goal is to build wealth over an extended time by buying and holding a portfolio using financial vehicles like stocks, mutual funds, and bonds.

Investments are held for years, or even decades, and, ideally, enjoy growth, compound interest, dividends, and stock splits. As we all know, markets fluctuate, but investors will ride out the downtrends with the expectation that stock prices will rebound eventually. You can often increase your profits by compounding or reinvesting profits and dividends into additional shares or stocks.

A clever investor will do their homework before investing and look at a company’s fundamentals, like its previous financials and industry analysis, as well as a country’s macroeconomic situations.

2. What is trading?

Trading’s goal is to generate short-term returns that outperform buy-and-hold investing. This involves frequent transactions, aiming for buying-low and selling-high instruments like stocks, commodities, and currency pairs.

So, while buy-and-hold investors may be happy with 10% to 15% annual returns, traders might want a 10% return each month.

But, trading is dynamic and volatile. Its high-risk and high-reward nature is at the direct and short-term mercy of the market, so it can incur both hefty profits and losses.

A trader has different homework to do. They need to analyse a company’s performance based on the uptrends and downtrends in the market in a single day. They need to use this analysis to predict changes and trends in volume, price, and moving averages.

What’s the difference between the two?

The key differences between investing and trading are their approaches: appetite for risk and time involved. As we’ve said, investing is lower risk and rewards over a more extended period, and trading is higher risk and higher rewards over a short period. Depending on your profile, you can choose one, the other, or even a combination.

So who earns more profit, investors or traders? Both have the potential to earn profits, but traders frequently earn more profit than investors when they make the correct predictions and decisions, and the market performs accordingly.

Investing vs trading. Which one is right for you?

Your first step is to decide on your investment strategy and goals. Are you saving for retirement? Are you looking for returns today? You also have to establish your appetite for risk, as this is a key differentiator between investing and trading.

Whichever one you decide, let’s look at how to do each wisely.

The clever investor

The smart investor wants to build long-term wealth, and here are some pointers.

1. First off, define your investment goal and decide on a strategy. Are you investing for retirement or saving for your kid’s university tuition? And how much risk can you tolerate when it comes to strategy?
2. Be prepared for the long haul. Know that successful investing takes longer, so your money will be tied up, and you’ll have less disposable cash.
3. Have patience and discipline to stick through the market’s ups and downs.
4. Form a plan for buying, selling, and rebalancing your holdings. For example, some investors sell some holdings and buy others to rebalance their portfolio to existing original goals if market fluctuations have thrown it out of whack.
5. Think about choosing index funds which don’t try to beat the market but mirror its performance. An example of such a fund in South Africa is the FTSE/JSE Top 40 Index.

The clever trader

The astute trader will always minimise risk. Here’s how you can do it.

1. Go in with wide-open eyes. The stock market’s long-term average return is 10%, and many studies have shown that it’s difficult for even professional traders to beat the market.
2. Plan when you’ll buy and sell. So, sell if a stock rises or falls by a predetermined percentage.
3. Stick to that plan. Even the most experienced traders change their reasoning for holding stocks and shares, and that’s not always wise.
4. Work out how much money you can afford to lose, and don’t trade more than that.
5. Take tax liability into consideration. Tax rates differ between short- and long-term capital gains.

So before you choose to invest vs trade, sit down, and think carefully about your goals and appetite for risk. Your future self will thank you for it!

The wealthy think about money differently from the average Joe, and that’s because they don’t need to work for their money and make their money work for them. So, even while playing with their kids, teeing off, or hiking in Patagonia, they earn income without lifting a finger.

But let’s say you’re not super-wealthy and want monthly income for your retirement. What are the best ways to generate this passive income?

First, let’s take a glance at why investing for monthly income can be right for you.

You may want a constant stream of money flowing into your bank account for many reasons. Who wouldn’t? But here are a few of them.

• An early retirement
• A more comfortable retirement
• Reduced dependence on your job
• Increased financial freedom

Whatever your reason to earn passive income, and there are definitely more than the above, there are many ways to do so.

Buy-TO-let property

This is one of the most convenient ways to secure a monthly income.

You can choose a commercial property or residential property. The best investment here is in the former: a building offered as a workspace. They attract a higher rent than other real estate, so you’ll earn a higher regular income. Residential property is the next most profitable, as these are living spaces; let’s face it, everyone needs a place to live.

So how do you pay for it? A mortgage is the most obvious if you don’t have the cash upfront. You’ll need tenants to enjoy monthly income so you can pay the repayments. Be aware, though. You’ll have to foot this bill yourself if you don’t have tenants.

The long-term benefit here is that, after the mortgage term is over, you’ll enjoy a net positive monthly income in the form of rent your tenants will pay you.

Equity Real Estate Investment Trusts

Real Estate Investment Trusts, or REITs, are companies that invest in real estate for you, so all you need to do is invest in them. You can choose Equity REITs which rent out the property for income, or Mortgage REITs which sell mortgages and loans.

It’s cheaper than buying a property because you’re only buying a share of the property, not the whole thing. But it does guarantee you dividends, which are usually monthly payments.

Preferred stocks

A stock or share means part-ownership of a company. There are two types, common stock and preferred stock. Common stocks give you partial interest in the company. In contrast, preferred stocks give investors more consideration when dividends are given out. You want a preferred stock here as it guarantees you a higher income, usually paid monthly.

Living annuity

A living annuity provides you with income during retirement. With this, you decide how to structure your savings within a basket of investments. You also choose how much income to draw within the regulatory limits of 2.5 to 17.5% annually.

A living annuity is popular because it provides transparency, investment flexibility, and tax efficiency. When you pass, as we all do, the remainder of the capital is transferred to your loved ones without estate duty or executor’s fees.

Short Term Bonds

Bonds are also an excellent way to gain a monthly income. They are debt instruments that the government, an institution, or a company issues to raise funds or capital. Essentially, you are giving them a loan that they repay with interest.

The interest that bonds earn is paid before the debt is paid back. That is how you can make a monthly income. The principal amount is paid back at the end of the term (known as the maturity date). Be cautious, though. Bonds come with a risk of default, so they don’t guarantee you a monthly income; you may lose your investment entirely. This is more true when buying company bonds. Government bonds are generally far safer. But be sure to do your investment homework!

Long term bonds

Long-term bonds last between 12 and 30 years. Thus, they come with the advantage of a higher interest rate but the disadvantage of a higher risk of default. If you have a lump-sum amount and want regular income, these are options. You can also invest in local bonds like unit trusts or on the JSE.

In closing, don’t think that the list above is exhaustive. There are many ways of investing for monthly income. Fixed deposits, money market accounts, and high-interest savings accounts will generate passive income. But because they barely keep pace with inflation, if they do so, many investors wisely choose one of the higher interest investments we’ve discussed earlier.

So, congratulations! You now have a source of monthly passive income. You can join the wealthy on their hiking expeditions, have a more comfortable retirement, or rely less on your 9-5. And what’s wrong with that!

Indices are designed to measure the performance of a basket of assets. In this article, we use equity/stock indices as an example.

Still, it is important to note that their application is asset class-wide and not only limited to stocks. Beyond performance measurement, indices play an important role in the world of financial markets. Many fund managers offer unit trusts and ETFs that track indices.

These managers are known as ‘passive’ managers. Active fund managers manage funds with the objective of outperforming their adopted benchmark, and the benchmark is usually an index. If we delve deeper and consider the world of derivatives, it gets a bit more complicated.

In a nutshell, you can buy a derivative, such as a futures contract, that tracks the performance of an index like the Top 40. You don’t physically own each stock in the index. The contract you buy will mirror the index’s performance very closely.

There are more nuances to indices and index construction than one would think.

A couple of FAQs related to indexing generally go along the lines of:

1. How is the weight of a stock in the basket determined, and what is a free float factor?
2. How are corporate actions dealt with? For example, for an equity index that measures the performance of a basket of stocks assuming dividends are reinvested, when are the dividends reinvested?
3. Are gross, or net of-tax dividends assumed to be invested? This is known as a total return index.
4. Can stocks go into an index and fall out?
5. Do index providers like the FTSE/JSE have a rule book that they follow when maintaining their indices?

The above questions are important to consider when developing your understanding of how indices work and ultimately understanding what an index is.

Let’s look at the answers to these questions below:

How are stock weights determined?

The weight of a stock in a market index is generally determined according to its net market cap. The net market cap is calculated by adjusting the total market cap by the proportion of shares available to trade. This is known as the free float factor.

The total market cap is the market value of the stock. It can be calculated by multiplying the stock price by the shares in issue. Many companies have low free float factors.  For example, take a stock with a free float factor of 10%; this means that 10% of its shares are available to trade. The rest could be held by a large strategic investor or the founders who have no intention of selling them in the short to medium term.

Imagine the stock was weighted by its total market cap. Passive funds tracking the index would have a tough time buying these shares as there would be very little available to trade in the open market.

Corporate actions – how are dividends treated?

The FTSE/JSE total return indices assume that dividends are reinvested on the ex-dividend date. The ex-dividend date is when new investors/buyers will not be entitled to the dividend being paid.

In practice, a passive fund manager can’t always reinvest the dividend on the ex-date as the physical cash inflow sometimes occurs after t + 3, which is the settlement date. This will create a small degree of divergence from the return of the benchmark, known as a tracking error.

There are two types of total return indices: gross and net. Gross total return indices assume that the full dividend is reinvested and no dividend withholding tax (DWT) is paid.

On the other hand, net total return indices assume that the dividend after DWT is reinvested. The reason why there are two versions is that some investors are exempt from DWT.

For example, locally, unit trusts managed by institutional investors* are exempt from DWT, whereas retail investors pay the full 20%. *Tax will be incurred by the investor in the unit trust depending on their tax circumstances.

Index reviews and stock changes

Depending on performance and corporate actions, stocks do get added and removed from indices. This is usually done at each review.

The FTSE/JSE indices get reviewed every quarter in March, June, September and December. Any free float or shares in issue data changes are also considered in this review.

Using the Top 40 index as an example, the JSE ranks constituents/members and non-constituents/non-members on the ranking cut date. This falls about a month before the rebalance date when changes become effective.

If there are non-constituents that rank at or above the buffer of 35, the stock will be added, and the lowest-ranking constituent will be removed.

Conversely, suppose a constituent falls to rank 46 or below. In that case, it will be removed, and the highest-ranking non-constituent will be added.

Rules-based or on the fly?

All the major index providers have a publicly available methodology and rule book. This is designed to create transparency around their index construction process.

The approach adopted by each can differ quite notably. For example, the MSCI is not as transparent with their ranking cut date as the FTSE/JSE and the S&P.

We hope this answers your question about what an index is and how it works.

With so many investment platforms to choose from in South Africa, how do you pick the one that’s right for you?

To help you decide, we have created a checklist of six questions you should ask your online platform to help you separate the good from the bad and the ugly.

1. What selection of investment do you offer?
2. Is your platform professional and easy to use?
3. What are your fees?
4. If you go out of business, what happens to my money?
5. What sort of information do you provide?
6. Can I speak to a human?

Let us take a look at each of these questions in depth.

What selection of investment do you offer?

Diversity is key to any successful investment strategy. You’ll want an investment platform that offers multiple asset classes across various exchanges. 

Check how many investment instruments they offer and what asset classes they cover. Make sure it offers more than just the local JSE and offshore exchanges. 

If you have an appetite for a particular type of investment, such as unit trusts. Check with them first—because when it comes to market access, not all platforms are made equal.

Is your platform professional and easy to use?

Most professional investment platforms offer advanced functionality, with usability being the direct trade-off. Assuming you’re not a character out of Wolf of Wall Street, you’ll want a platform that strikes a balance: offering all the bells and whistles that are just as easy to use.

DMA’s TraderGo platform, for example, is a professional-grade platform that combines sophisticated tools with a flexible layout. Making it easy to surface only the tools you need. 

When looking for the right investment platform for your money, you’ll also want to check if the platform makes it easy to switch between desktop, tablet and smartphone.

A good idea is to ask for a demo account, which will give you a good feel for the platform without using real money. 

What are your fees?

Fees (or commissions) are what online investment platforms charge for their services. Some require an initial minimum deposit to fund your account.

All investment platforms will charge either a flat fee or a percentage for every trade you place—all of which will eat into the relative performance of your investments. 

As with most things in life, you get what you pay for, so you’ll need to work out what you value and how much you’re willing to pay over in fees. 

If you go out of business, what happens to my money?

The safety of your assets is one of the most important factors to consider—if the investing platform goes under, your money shouldn’t go with it. 

DMA uses two banks in the UK, HSBC & Crowns Agent. All transactions are recorded and held in a separate trust, so your money is always retrievable. 

What sort of information do you provide?

The financial markets can be a wild and lonely place. An investment platform should do more than provide access to the market. It should educate the investor, keep them informed with up-to-the-minute news, and provide tools to help manage your risk. 

Can I speak to a human?

A good investment platform isn’t just about the tech. It’s about the people and customer support behind the tech.

• Can you find a phone number on their website?
• Can you speak to someone with a name, not just an automated bot?

When timing is of the essence, knowing you have people you can trust looking after your account is essential. 

Picking an investment platform or investing app that suits all your needs and ensures that your money is well looked after can be tricky. No one can make this decision but you. Using the six questions as a starting guide will make the process slightly less daunting.

(Full disclosure: This blog is paid for by DMA, whose investment platform is mentioned in this article. We believe the platform ranks right up there with the best, but you’re encouraged to do your research before deciding.) 

“Money isn’t everything, but everything needs money”, as the saying goes. These words could not be more appropriate but reveal that the relationship between most people and their money is very fragile.

Money-related matters cause anxiety, and the fear of running out of this commodity is real. When, on rare occasions, individuals are not worried about their money or paying the bills, many adopt a “head in the sand” approach. They abdicate their financial responsibilities to their bank or financial advisor or ignore them, hoping the wolf at the door will magically vanish. 

It’s never too late to “money better”

Fortunately, it’s never too late to “Money Better”. By this, we mean making your money work as hard for you as you do to earn it—and to feel good while doing it, giving you financial wellness. Let’s not be mistaken; by practising “Money Better”, we are not advocating for a simple DIY approach to handling your finances; we want you to feel better about your financial assets.

DMA believes there’s a middle ground between DIY and advisor-led investing, an approach that provides a guided architecture or set of guardrails that nudge your investing behaviour in the right direction. Bringing you closer to your money.

“Not all of us are expert carpenters or handymen,” says Richard North, CEO of DMA, “that’s why we turn to functional solutions like IKEA, which help you assemble a piece of furniture with easy-to-follow instructions, giving you a sense of ownership and pride in what you created. Building wealth should feel the same way.”

The two main reasons people invest are out of fear or greed, but this need not be the case once you embark on a journey to take control of your money.

Education about saving and investing is key to building a better relationship with your money. Take the time to learn more, even just a little daily. The compound effect of your knowledge, much like the compound effect of long-term investing, might surprise you. Above all, be kind to yourself and move at your own pace.

Saving and Investing should be positive

Saving should be a positive experience and investment even more so. Think of all the products around us. Then imagine that you could have actual ownership in a company like Coca-Cola, to name but one of the thousands, and you will realise how exciting the investing world truly is.

The opportunities available to you are endless. Once the investment bug bites, you will not only have greater peace of mind regarding a brighter future for yourself and your loved ones. You will also experience how contagious and thrilling investing in the stock market, but ultimately you can be.

Now is the time to rekindle your relationship with your money, and the great news is that it’s never too late to “Money Better”. Being better with money starts with feeling better about money.

Embrace your money; after all, you work hard to earn it. You’ll be all the better for it.

(Full disclosure: This blog is paid for by DMA, whose approach to investing and money wellness is referenced in this article.)