If you have money to invest – whether it is R1,000 or R100,000 – think about it carefully, make the most of tax breaks and make sure your savings are in a fund where you get the lion’s share of any growth.
Whether you are starting an investment that you plan to build up over time with small, regular contributions, or have come into a large chunk of money that you want to invest, you should ask yourself some basic questions before you decide how to invest your money.
What is your investment goal?
Are you saving for a ‘rainy day’, a child’s education, an engagement ring, your retirement, a holiday, the deposit on a house?
How will this affect how much tax you pay?
You get tax you have paid back because you have made certain investments, such as saving for retirement, while growth on other investments will attract tax charges.
“In this world nothing can be said to be certain, except death and taxes.” So said US Founding Father Benjamin Franklin, but how much tax you pay is far from certain. It is basic good practice to take advantage of tax relief available to you via a retirement savings vehicle and a tax-free savings account.
If you are investing money and you haven’t used your tax allowances you are in effect saying ‘No thanks’ to the government’s offer to return some of the tax you have paid.
Money you put into a retirement annuity attracts various forms of tax relief:
• Up to 27.5% of your taxable income, up to a maximum of R350 000, is tax deductible.
• You do not pay tax on investment returns, such as interest income, dividends, and capital gains.
• You can take up to a third of your RA as a lump sum when you retire (or all of it if it’s worth less than R247,500), with the first R500,000 being tax-free.
Income from unit trusts is taxable:
• If your unit trust holds cash, it will generate an interest income, which is taxable. (Every investor qualifies for a tax exemption up to R23,800. If you are 65 years and older, R34,500 qualifies for tax exemption.)
• Equity investments generally generate dividend income, which will be paid to you after tax of (only) 20%.
• Capital in a unit trust is expected to grow. The growth (your gain) will attract capital gains tax. An annual exclusion of R40,000 capital gain is granted to an investor when an investment is disinvested, house is sold etc. On capital gains above that R40,000, only 40% is liable for tax, meaning a further 60% of your capital gain is exempt.
When do you need your money?
Money you have saved for retirement is locked up in an investment that is geared for long-term growth, removing temptation to spend it, and making it easier to make good choices.
If you are saving for something in the shorter term, unit trusts or tax-free savings accounts are good ways to invest discretionary income.
Unit trusts provide you with liquidity (access to your capital) and flexibility to choose how the money is invested. On the downside, the growth (income) can be taxed (see above) and there can be multiple fees involved. With unit trusts you can invest in a wide selection of assets at a relatively low cost. You can also invest a small sum of money (a minimum of only R500 with most investment companies).
What is your appetite for risk?
Within unit trusts there is a lot of choice. You will need to select your investments based on your personal circumstances and goals, as well as your appetite for risk.
Once you have selected a unit trust, you will need to decide which funds to invest in. Different funds invest in different assets, from cash and bonds to property and equities (shares), both locally and abroad. Some unit trusts focus on investing in bonds, while others focus on the higher risk, potentially higher return world of equities. Yet others still diversify (and lower your risk) by investing across all investment types, both locally and abroad.
Another choice to consider is between active and passive fund management. Simply put, active managers pick individual stocks, effectively taking a bet that they can select the winning stocks of the future. Index fund managers, on the other hand, buy a small slice of the market as a whole and focus on keeping costs low.
There have traditionally been strong opposing views, but increasingly the global investment community is following the wisdom of the great investors of our time, including Warren Buffet and Jack Bogle, and buying a slice of the whole market at a low cost.
How much will an investment cost you?
Cost is another very important factor that you should focus on. Costs include advisor/broker costs, administration/platform costs and investment management/fund management costs. The average paid by South African investors is around 3% per annum, which is more than 2% above what 10X Investments charges for its high performing unit trust.
People often forfeit most of their investment growth – in other words their earnings – to high fees. Even an extra percent here and there will compound over the years to become a large hole. You can select the right investment vehicle and the right asset allocation, and it can all still go horribly wrong when there are high costs involved.
What about fund performance?
Make sure you have a look at the asset manager’s track record before you sign on the dotted line. It is preferable to look at a 10-year track record at least. The process of finding information about performance might answer another question you should ask...
Do I understand what I am in for?
It is important to understand what you are getting yourself into as this may be a long-term commitment. Do you understand the investment strategy and the fee structure? Will you be able to see how your savings are performing? If it is not simple enough to find out what you are investing into and at what cost, ask yourself why.
Take time to find as much information as possible and to weigh the pros and the cons so that you can settle on the best investment for you. Whatever you decide, your future self will thank you for taking the time to ask yourself these questions.
