Debt is clearly on the rise

DebtBusters quarterly analysis for Q2 2020 clearly shows how consumers’ exposure to debt has significantly deteriorated over the lockdown with higher-income earners in particular under debt pressure.

This is borne out by the increase in unsecured debt, which on average is 18% higher than it was four years ago. For consumers earning more than R10,000 per month, unsecured debt is 31% higher – for those earning R20,000 or more per month, the unsecured debt levels are 42% higher than 2016 levels.

Treating the symptom and not the cause

Unsecured lending tends to be is an easy way out. This form of loan is not attached to your property but instead comes at an extremely high rate of interest. 

So for those under pressure to meet their debt repayments are not finding the solution to cutting back on their lifestyle expenses –  instead are they turning to more debt to get out of debt. 

The global economy is on the same track

Countries are also doing this in an attempt to save their economies. The consequence is higher debt levels and low growth. South Africa’s debt will exceed 100% of its GDP in the near future on current projections. 

Take control 

The solution is found in taking charge of how you spend your money. The pain is far less to bear by cutting back on your cost of living now than losing everything when the lender takes your property from you when you default. 

Take advantage of lower interest rates

There should be some room to manoeuvre with the sharp drop in the interest rate this year making the cost of debt cheaper. The savings should be used to reduce your debt. 

Act quickly if you are not coping

Debt counselling is an option that should be considered at the earliest sign that you are not making it. Borrowing more money is simply kicking the proverbial can down the road.

A linked investment service provider (LISP) is probably one of the lessor-understood investment vehicles. Most investment houses have them and have been around for a while.

What are they?
They are investment platforms which offer access to a universe of investment options from shares to ETFs and Unit Trusts. They provide all the investment policies such as endowments, retirement annuities and preservation funds. So you can invest in, say, an endowment with a LISP provided by Momentum and choose from a variety of funds from Old Mutual, Sanlam and Liberty Life.

The advantages of a LISP

One administration
You have one application and one statement for a variety of investments providing a ‘one-stop shop’ without placing all your eggs in one basket.

Switching funds
You can easily change your funds without having to change your policy. Policies have terms and conditions in their contract which affect the payment. If you change your policy prematurely then you could lose benefits. You can keep the policy at the LISP and simply change to funds with another company maintaining the benefits.

Fees
Most LISPs offer a discounted fee structure based on the value of your investments on their platform. This may save you a sizeable amount over time compared to saving directly with a number of different companies.

The financial services world is complex and it pays to simplify. A LISP provides an easy and simplistic solution. Speak to your advisor.

The South African Reserve Bank (SARB) cut interest rates by another,25% on Thursday which brings the total reduction in interest to 3% for 2020. The repo rate which is applied to banks is now 3,5% and the prime lending rate applied to consumers is now 7%. The lowest in 4 decades.

So how does this affect us?

Great news for indebted households –  3% off debt costs is a significant reduction in living expenses: A mortgage bond of R 1 000 000 at the beginning of the year had a monthly instalment of R9 650 per month when the prime lending rate was 10%. After the additional rate cut on Wednesday, the same bond now costs R7 752. That reduces the debt by R1 898 per month.

Add to this the savings on other forms of debt such as overdrafts, credit cards and car instalments household living expenses should be far better off. 

Sad news for pensioners – It’s a case of ‘one man’s meat is another’s poison’, for those households which depend on interest-bearing savings for an income. A pensioner with R 1 000 000 savings is now earning R2 500 less.

What you could do – Paying off your debt with savings is an ideal plan for those whose income was not affected by the COVID-19 lockdown. Not many South Africans are in this position but even if you can allocate a small amount to paying off your debt more quickly this will pay dividends in the future. 

Pensioners could look to Unit Trust Income Funds which focus on investing in cautious assets such as bonds and cash. When interest rates go down bonds tend to go up. Be aware of the fees that are applied as your return is net after costs. RSA Retail Bonds may also be an option with no fees at the current top rate of 8%.

The saving grace for us all is that inflation is way down to 2,1% – the lowest in decades which is a direct reflection of how the lockdown has affected the economy. We should brace ourselves for taking every opportunity as we navigate through the devastation of this pandemic on the global economy.

In a depressed economy returns on various investments are weak if not negative. The South African Stock Market year to date is -2,3% with a total return of 0,6%. Fees become more noticeable when returns are low as they appear to reduce your returns leaving less for income and or growth into the future.

Fees are effectively a reduction in yield                                                 

This means that if you earn 10% and your total fees are 2%, you get 8%. To get an idea of the impact of fees over time – R100 rand over 10 years gets you R20K @ 10% and R18K @ 8%.

Here are the components of fees:

The Service Provider of your investment Charges on average 0,5% per annum for the administrative work needed for your investments. Providing information and technologies to keep you in touch with your investment.

The Financial advisor who helps you to make appropriate choices on your investments can charge up to 1% per annum on the value of your fund.

The Fund manager who your invest according to a specific objective which you decide to invest in charges between 0,5% and 2% depending on the type of fund.

SARS also has a part to play in reducing your yield as all the fees have VAT applied at 15%. SARS also taxes your returns and collects on capital gains as well.

You could save on advisor fees by investing directly. The downside is that you could end up with an investment which costs you more because of wrong choices.  

You could save on Fund manager fees by investing in passive funds. Investments like Exchange Traded Funds and tracker funds offer the average performance of the basket that they represent. The cost is generally lower. The downside is that your returns will never be better than the average. 

You could save on Tax by investing more wisely in certain ways to limit taxes. You will need a good understanding of the various tax breaks on certain investments to take full advantage.    

It comes down to the value you perceive. It’s not only the returns that you need to be focussing on when assessing fees. The value proposition also lies in the appropriateness of the investment aligning to aspects like tax advantages and avoidance of estate duty and other costs. There are certain structures which improve your investments in more ways than return.

So be aware of the full value proposition of your fees. They are justified if they add more value to your investments than you can.

A retirement annuity is an investment for your long-term financial future. It is the vehicle which will provide an income for you once you retire. South Africans do not have a safety net to fall into. You are on your own despite the number of years you have paid your taxes to the economy. The COVID-19 pandemic has pushed those who don’t have ‘emergency funds’ to consider cashing in on their investments to survive the devastating financial impact on their lifestyles.

Your contributions reduce your tax

 Regulations allow contributions towards a retirement annuity to be deducted up to 27,5% (including pension contributions) against your taxable earnings.

So, if you earn R100 000 you can deduct up to R27 500 of contributions toward retirement funds reducing your taxable earnings to R72 500. So there is a huge benefit(

if you can afford it),to contribute the maximum. Effectively, you get a refund at whatever your tax rate is. If you pay 40% tax you get back R40 from every R100.

Your returns improve

The returns received in your retirement annuities such as dividends, rental income and interest from bonds and cash are all exempt

from tax. This significantly improves the compounding value of your retirement annuity into the future. If you invested in an endowment you will pay 30% to SARS

and if you invested in a unit trust or a money market fund you will pay back at your tax rate. 

Options during the Lock Down

Your retirement annuity is only accessible at age 55 at which stage you can access one-third of the value subject to tax. The remaining two-thirds have to be invested in a pension, of which there are many options. The resulting income will be subjected to tax. So, if you are considering your retirement as a form of relief is aware of the tax implications. 

• If you are 55 plus you can draw your third and then invest in a living annuity. If the two-thirds is below R125 000 you can then cash in subject to tax. 
• If your retirement annuity is under R125 000 you can cash in subject to tax.

Retirement annuities come with restrictions which have tax advantages but are restrictive when it comes to accessing the cash. 

My view is we should be allowed to access the full funds just as employees of pension and provident funds can when they leave their employers. Why not?

The budget speech delivered by our finance minister this week unveiled the state of our devastated economy with mind-boggling numbers in deficits and loans that left the average South African bewildered and ‘gob smacked’. The big elephant in the room is ‘Why did we allow ourselves to get here in the first place?’ Prevention is always better than cure and now we have to take the hard way…..We could have and should have changed our sails before this storm..it would have been much easier than having to take the hard road ahead.

Yes, we all knew that the lockdown was going to damage our economy but the COVID-19 pandemic merely accelerated us on the path we were heading for anyway. Before lock South Africa was living on borrowed time with a pending downgrade to ‘junk status’. This was quickly implemented when we went into lockdown in March and then soon after came the second downgrade which further degraded us.

What can we take as South Africans take away from this?  

Cling to your job if you have one                                                                

Pay cuts are likely as business needs to contain expenses to survive this storm Unemployment is catapulting into record levels and there will be many South Africans too willing to earn something rather than nothing.

Act quickly if you are on the tipping point of a personal downgrade Face the music with urgency, assessing your own damage. If you took any of the relief packages to assist you in the lock your cost of debt has increased and you have to start paying back soon. Fortunately, we have had a few rate cuts this year opening a small window of opportunity to settle the debt at a lower cost before interest rates move up again. 

Avoid being enticed into quick fixes                                                    

Casinos will be opening soon and there is a very real temptation for some South Africans to look towards gambling as a way out of their financial woes. This is a sure way to further destruction if you gamble with money you can’t afford to lose. Think about it….if you have debt costing say 10%  the money lost at the casino costs you that much more as it could have been used to reduce your debt. You should only be in a casino if your debts are all paid up and you have set aside a meaningful amount for savings.

Leave your retirement fund alone                                                    

 Accessing your retirement savings should be a measure of last resort. The tax payable is probably much more than the interest costs of your debt. Your financial future is also severely damaged as you effectively wipe out the crucial benefit of time required for compounding your investment. 

Real hard times lay ahead. South Africans will need to dig deep into their resilience doing everything possible to stave off the effects of our state of the economy.

Warren Edward Buffett is an American investor, business tycoon, and philanthropist, who is the chairman and CEO of Berkshire Hathaway. He is considered one of the most successful investors in the world and has a net worth of US$88.9 billion as of December 2019, making him the fourth-wealthiest person in the world.- Wikipedia.

Buffett runs Berkshire Hathaway, which owns more than 60 companies, including insurer Geico, battery maker Duracell and restaurant chain Dairy Queen.

So what can we learn from Warren Buffet as we stand stuck in a deep recession wading through a pandemic which has left us guessing at the outcome?

Warren Buffet has some truisms which have navigated his way to his fortunes. Let’s explore some and learn a few things to help us along. 

Invest in what you know…and nothing more.

So when you make a call on Bitcoin or Gold or even the currency, how much do you know about what you are investing in? Far too often we rush into investments 

not doing our homework. Warren Buffet prefers to leave investments he does not understand well alone.

When you buy a stock, plan to hold it forever

“If you aren’t thinking about owning a stock for ten years, don’t even think about owning it for ten minutes.” 

A sound strategy but COVID19 changed all that and he was realistic enough to make an exception to this rule. 

Buffett has remained relatively quiet during the coronavirus market downturn: Rather than make any large acquisitions, he’s trimmed Berkshire’s holdings—mostly banks and airlines so far.

Buffet’s biggest recent move was to sell off 84% of his stake in Goldman Sachs, a longtime holding which he famously invested $5 Billion into during the 2008 financial crisis.

Buffett decreased his stake in Goldman from over 12 million shares to just under 2 million which saw the stock plunge over 30% in the first quarter.

Warren Buffett sold his Airline Stocks during the pandemic because of debt and over capacity. Berkshire Hathaway disinvested in American, Delta Southwest and United Airlines. Another deviation from his rule in the face of the global pandemic. Makes you wonder about SAA and how we carry on pouring money into its debt and overcapacity?

Know the difference between price and value

“Price is what you pay. Value is what you get.” – Warren Buffett

His understanding of value ‘stands out’. Many investors know the price of a stock but not the value. Warren buffet made the point during the 2008 financial crisis 

During the extraordinary financial panic that occurred late in 2008, I never gave a thought to selling my farm or New York real estate, even though a severe recession was clearly brewing. 

Taking it a bit further, his appreciation of value over price is seen in his lifestyle:

Buffett is reportedly worth more than $80 billion. When he purchased his previous new car in 2006, he chose a cushy, but not outrageous, Cadillac DTS, priced at about $45,000.

Warren Buffet’s Portfolio

It has an enormous pile of cash that earns interest while waiting to be invested in a business or other productive asset.

In this uncertainty we can learn from the most successful investor ever. The biggest lesson from my point of view is ‘keep it simple’ – “do your homework but don’t be stubborn when you need to change’ and ‘know the value of your assets’. 

This has been a strategy applied by investors in the stock market over the years. It is a classic market adage which is also known as the Halloween Theory as the time to re-enter the market is after Halloween. (End of October). The saying dates back to old England when the stockbrokers would go on summer vacation in May and not return until September.

Changes were gazetted on the 1st of June governing conditions regulating living annuities. This is an attempt to help retirees have more access to their funds if they have been affected financially by the lockdown through COVID-19.

What is a living annuity?
When you retire you have two types of pension to choose from:

A life annuity – is a pension offered by a service provider which is guaranteed for the rest of your life. The liability of delivering the pension belongs to the service provider.

A living annuity – a pension which you are responsible for and manage. You decide where to invest and how much to draw as a pension. The main risk is drawing more than the fund is returning over time. For example, if the fund returns 5% in a year and your draw 10%, you reduce your investment by 5%. Over time, your capital reduces more rapidly as your income needs to take more of it.

The temporary changes

Living annuities allow you to draw between 2,5% and 17,5% per annum of the value of the fund.

Investors who want to change the income level of their living annuity have the opportunity to do so before their living annuity’s next income review (anniversary) date. The range has also been adjusted to a minimum of 0,5% (for those who feel they would like to protect more capital) and 20% (for those who need more income).
Changes can be made up to 30 September 2020 when they will revert back to the previous range.

So what should you consider?
If your living annuity has lost value this year as the markets crashed in March and then recovered, somewhat, you will need to assess the percentage you are drawing relative to the value of your fund. If you increase your income level in this interim period you could well eat into your capital which will deplete your funds in the future.

If you have other resources you could reduce your percentage drawdown and leave more capital behind for growth.

Another significant change
Before the 1st of June, you could cash in your living annuity if the value was below R75 000. This limit has now been lifted to R125 000. Be careful as tax could be applied. You should get a simulated tax directive in the first instance to determine if it’s worthwhile cashing in the fund versus drawing the income and paying less tax over time.

The bottom line is found in drawing less than your returns over time allowing your capital to grow. You may need the extra income now to help through this pandemic but be mindful of the impact on your living annuity into the future. Be careful not to get lulled into taking on risky investments with an unrealistic expectation of higher returns which are not likely as we unwind the lockdown and discover the damage to the economy.

After more than 60 days in lockdown, we have had a long time to think about many things, including money. We’ve seen how important it is to have enough to get by. Those who lost some or all of their income had to learn how to stretch their provisions to meet their basic needs forgoing the niceties which were so taken for granted.