The investment horizon is never really certain. However, the current global economic climate is definitely more uncertain than before. Economies throughout the world are battling to create employment and dig themselves out of the debt. Doubt, fear and worry loom. Yet the markets are performing at all time highs pointing to hope and expectations which, frankly, do not align with economic fundamentals. This all adds to further uncertainty. So how should you approach your investments in these uncertain times?
Be realistic with your expectations
Past performance is not a prediction of future performance. Yes, looking back through a rear view mirror is pretty accurate. However, predicting the future is pretty well impossible. So, understand how your investment achieves its return and measure this reasonably against future expectations. If the share market. for example, relies on a a healthy economy, then it stands to reason that future returns should be better. However, the converse applies. You cannot reasonably expect double digit returns when the economy is benign.
Time in the market
Firstly, you need to decide on how long you intend to invest for. The basic principle being that the longer your horizon the more risk you can afford to take. Risk is found in the share markets where historically you receive higher returns than the other asset classes. Shares are bought in expectation of profits made by companies which are passed onto the investor in the form of dividends. If companies make consistently high profits over time then investors are prepared to pay more for the shares. However, there is a problem. The share market is driven by emotion and speculation in the short term and this often defies the fundamental view. Case in point, the current economic condition of our planet and the all time high performance of our stock markets.
Spread your investment
Once you have your time horizon established then you should consider your options. Look at a balanced fund approach. Take two or three unit trust funds that offer a flexible balanced objective. These fund managers make the calls for you deciding on where and how much to allocate to various options. If you choose a few funds then you get the advantage of different styles and choices from different points of view. That’s a lot of attention on your money.
Investing a lump sum in the markets in times like these is very risky as you have a strong possibility of loosing capital. If you lose 50% of your money you need 100% to get back to even. Who knows what the new normal returns will be into the future? It could take years to break even.
A safer way is to spread your investment into your new funds over time. The longer the period the less risk. Choose to keep your money in cash and then phase in over 6 to 12 months to avoid any severe loss of capital. If the markets correct during your phase in then you can take a position with the remaining balance at a discount. If you save on a monthly basis then you benefit from a bearish falling market which, if sustained for a long period, will mean that you will be buying discounted shares for a while and benefiting when the valuations pick up again. It’s all about preparation and patience in the end.
A word of caution. Don’t be lulled into the expectations of your investment based on the past fews years. Be realistic, understanding that there is a long way to go before the world gets back to normality and the returns in the new normal will probably be more benign than the performances of the past. At the moment cash at 7% is more certain than other assets. So not a bad option for the time being.
Our Minister of Finance announced in the budget proposals this week an increase in withholding tax on dividends from 15% to 20% which further erodes the returns you receive from being invested in shares. This gives you even more reason to be invested in a tax free savings account (TFSA).
If you move quickly there is still time to get invested before the tax year end on the 28th February.
If you are invested in unit trusts or exchange traded funds you should consider the comparative advantage of having the exact funds invested through a tax free savings account.
Tax is applied to all sources of returns If you are invested in a balanced unit trust fund, you are probably attracting tax on interest from money markets and bonds, rental income from property investments and tax on dividends from shares. These deductions erode the return on your investment.
Beef up your compounding effect Growth on your investment is largely dependent on compounding of your returns over time. If you reinvest the growth every year you effectively achieve growth on growth into the future. Over time this becomes a mathematical phenomenon rocketing your investment value over time.
So it stands to reason that if you invest in the exact same unit trust through a tax free savings account your return will be that much bigger because not tax is deducted. Compounding on this higher return simply means more for you in the future on the exact same fund. A no brainer!!!
Capital Gains is neutralised If you disinvest your current unit trust and reinvest in a tax free savings account up to the maximum annual allowance of R30 000 (next tax year R33 000) you will significantly beef up the performance of your investment. The potential Capital Gains Tax which will be applied to selling off your unit trust will be offset against your annual exclusion amount of R40 000.
So if you made the investment before the end of February you have taken full advantage of the tax break for the year on CGT and maximised your allowance for investing in the TFSA into the future.
The road to financial independence is a journey. You know you have arrived when you find the stage in your life where you work, live and do the things you really want to because you are not reliant on being on a payroll.
Imagine the freedom to do what you want to because you have sufficient income to maintain your lifestyle which comes from the savings and investments you have acquired over time.
Very few of us achieve this in our life times and yet it can be attained with the right approach.
Work on earning interest instead of paying it
If you are borrowing to maintain your lifestyle your standard of living is too high relative to your income. You should be able to service your debt comfortably after having firstly set aside the appropriate amount for savings.The cost of your total debt should not exceed 30% of your monthly income. If it is higher then you probably should be living in a smaller house or driving a cheaper car. The higher your debt the more you are paying the bank instead of yourself. The opportunity is lost in diverting interest repayments to compounding investment returns.
Don’t rely on luck
Many of us dream that one day in the future we will strike it rich in some business or win the lottery.
We then don’t see the need to save along the way which ends up in starting to save to play catch up and often ends up being too late.
The only realistic way to have a chance of building enough capital is to take full advantage of compounding. The sooner you start saving the less it will cost you as the power of compounding increases exponentially the longer you save. Its the only magical way to reach financial independence, but it does need time to make it happen.
Keep it real
Ignoring the value of money now and into the future will stand in the way of being financially independent. Many of us are more ready to spend now rather than save for the future.
Be realistic with your lifestyle needs and keep close to how your investments are keeping pace with inflation. Your financial independence will be greatly affected by the ravages of this enemy into the future. Investments over time will need to perform at a higher rate of return than the inflation rate.
Your financial independence relies on setting aside enough over time compounding at a higher rate of inflation.
You work hard for your money so use it wisely.
Wether you earn R10 000 or a R100 000 per month the basic objective in your financial planning is to be able to maintain the standard of living that you have accustomed yourself to no matter what life changing event comes your way. It could be a death, disablement, marriage, divorce, retirement….
Allocate 30% of your income to provisions for the maintenance of your lifestyle. This includes medical aid, insurance and investments. These provisions provide safety nets should you face a life changing event. They should be able to provide sufficient financial support to maintain your monthly needs.
The investments should initially aim for the short term to build up enough to cover your monthly expenses for 6 months. A money market account is ideal for this provision. Once in place you should then allocate your savings to the medium term (5 years). A super place to invest is a tax free savings account. You could also consider unit trusts and exchange traded funds.
Now your plan is developing. You have insured yourself and your assets for any unforeseen expenses and have cash and investments in place for the next 5 years.
You will have funds in place for funds a deposit on cars, holidays, emergencies….even if you are retrenched you can carry yourself for 6 moths.
If you need to buy a house or car you are well positioned financially to afford it. The cost of your debt should ideally be below 30% of your income. So your repayments on your car and house should not exceed 30% of your earnings.
Paying off this debt sooner than later will provide you with more disposable income to either save more of or improve your standard of living. As long as you have set aside your 30% for provisions you can do what you want to with the rest.
Using your income wisely will give you peace of mind which is the ultimate benefit of a sound financial plan.
Institutions make their money by lending money to you at a rate over the time. Simply, the long you take to pay the more it costs you and the banks thrive on it.
Debt is so easy to get into and so very difficult to get out of. Prevention is always better than cure but the reality is that we get enticed into debt over time and soon find ourselves in it way too deep. The cost of debt climbs quickly and robs us of the potential to create wealth.
You can benefit by reversing the formula
Interest + time = profit
You cannot reduce the interest rate but can reduce the time = less profit for institution
Less interest for institution means more savings for you
More savings for you compounded over time = more wealth for you
Here are 3 steps to getting ahead of your debt
Coping with debt is like trying to fill up a bath leaving the plug out.
Put the plug in by making a conscious decision to get out of debt. The culprits need to be identified and cannot be allowed to increase anymore.
Credit cards, overdraft, personal loans, store accounts, even outstanding taxes. All have to stop if you want to reduce the time to pay off your debt.
Open up the tap with your disposable income. This is the money that is left over after your cost of living during the month.
Focus on living expenses. Split your expenses into ‘nice to haves’ and ‘must haves’. This is the hard work. Being honest with yourself in identifying what you need and what you can do without.
Keep a close eye on the water level. Divert the new found savings back into the debt instruments.
Targeting the highest interest bearing one first and then working through the next. Patiently keep your living expenses well under control. A new year brings on a wave of price hikes. So your cost of living will is going to increase anyway forcing you to squeeze those living expenses even more.
It is a classic case of ‘no pain no gain’, where the benefits are certainly well worth it!
The risk of losing everything is very possible with the current heavy rains all over the country.There have been reports of severe flooding which has destroyed property and taken lives leaving families devastated and financially ruined.
Insurance is the easiest way to cover for this potential loss. Insurance is necessary if you do not have sufficient capital to replace the loss. It is expensive if you never claim, however, if you have a loss it is the best value for your money.
If you are not insured as many South Africans are, then you will need to cary your own risk. You will need to assess the replacement value of your property very carefully and make a plan to provide for the potential loss. You can conduct you own cost/benefit analysis and choose to set aside an amount which you would have paid to an insurance policy and save it yourself.
Emergency Fund The starting point in any sound financial plan is a contingency fund for emergencies. The larger this fund the lower the risk you run of not being able to replace your property.
Many people try to self insure this way. Saving extra cash in your bond or money market account is ideal. If you are victim of a flash flood you can access this fund easily to replace your household items. You may be able to salvage some things but you need to understand the financial impact should you lose everything.
Prioritise Your Inventory Draw up a detailed inventory of all your belongings at current replacement costs. Prioritise the more important items such as fridge, stove… as these are essentials for the family over, say, the TV and sound system and will have to be replaced first. So aim to save up for these items first.
Having provisions in place for an unforeseen life changing events is what financial planning is all about. Catering for the short and long term will provide you with the peace of mind that you and your property is protected no matter what disaster may come your way.
When deciding to invest on your own you must be prepared to do your homework.
Here are some investments which you can consider investing directly into.
Money Market Account For contingencies and emergencies it is important that you have ready access to cash. A money market account offers you access to your money at an interest rate which is normally better that fixed deposits. Banks have certain conditions which you need to explore, such as, minimum balances to keep the account open and how often you make withdrawals. Ideally, you should have this account accessible on your internet banking profile so that you can manage your savings more easily.
RSA Retail Bond
A bond is an investment in debt. Effectively you are lending money to government for a specified period. The case of RSA Retail Bonds the periods are 2, 3 and 5 year options. The interest rates are generally higher than the current money market rates and there are options to link your rate to inflation. This is an ideal investment for those needing interest to supplement their pension as the interest can be paid out monthly to investors who are 65 and older.
Exchange Traded Funds (ETF)
In the universe of investments choosing the right fund manager can be daunting. There are so many styles and objectives which funds are defined by. An easier approach is to invest in a ETF which invests in the average of the market. There are many types such as SATRIX 40 which offers the top 40 shares listed on the stock exchange by their size of company. For as little as R300 per month you can participate in quality stock market shares.
Understand the investments you make as thoroughly as possible beforehand. That way you will enjoy the power of saving over time using the the magic of compounding.
Most of us have an idea that we will retire at 65 and live happily ever after planning golf a few times a week and traveling around the world and back again. Nothing further from the truth when you take a look at the stats of South Africans at 65 and their degree of financial independence.
In the 3 decades that I have been in the industry the statistics have n’t changed.
47% rely on on their families for financial support
31% have to carry on working
16% rely on the state for a pension
This means that only 6% of South Africans are financially independent at age 65. This means that only 6 % of us can maintain our lifestyles after age 65 for the rest of our lives. What makes this statistic more challenging is the fact that we are on average living much longer than our parents. So the 6% probably waters down to half.
The stats are overwhelming. Retirement is an illusion for most of us.
Furthermore, many of us have the dream to retire by the coast and open that coffee shop which will provide us with the purpose and the income we need for the rest of out lives. Be careful! More often than not the business is a lot tougher than you imagine. Coffee shops needs a lot of coffee to cover the rent and expenses leaving very little behind for an income to maintain your monthly needs.
In many cases it would be a better proposition to keep the pension and use the bank’s money to float the business (if you can secure the finance). If you cannot get a loan than that would speak volumes to the feasibility of the business because if the banks are not interested then the chances of making it are diminished.
Pension funds are inalienable which means that your creditors cannot touch it if the worst happened and you went insolvent. So the sweet spot is found when you lend from the bank and keep your pension fund. At least you have something to fall back on.
Whether it’s just retiring or working at the coast it boils down to how much you need to maintain your monthly lifestyle and how long you will need to provide for. The ravages of inflation will place extra pressure on you as well.
The reality is that most of us will have to keep on working. Not a bad thing as it creates a purpose for us to get out of bed every morning. Just be aware of holding onto your pension for as long as you possibly can. You don’t get a scone chance to build it up again.
A great place to save in the short term is your home access bond. With home loans around 10% by saving extra in your bond you effectively get this rate as a return on your money.
Why? Well because the bank calculates the interest owed from the average balance in your bond during the month. It then takes the interest from your monthly installment and allocates what is left behind to paying off your loan. The higher your balance the less interest you pay and the more is allocated.
When assessing an investment you need to consider the following:
Risk – the possibility of losing capital
Return – the yield of the investment over time. This could be interest from cash deposits or bonds, rental income from property or dividends from shares.
Liquidity – how freely are the funds available?
Costs – the charges applied to the investment. Mainly the fund manager, the administrator and the advisor.
Tax – taxes are applied to the various returns as well as capital gains tax when you sell the investment.
When taking all these aspects into account it becomes obvious that the access bond is by far the most effective vehicle in the short term. Especially while interest rates are on the up. In this cycle shares and property and bonds tend to fall while interest bearing accounts tend to rise.
Where can you currently get 10% tax free without risk or costs and your money is immediately available to you.
Some may argue that the other assets are more effective over the long term. However, for the foreseeable future it is difficult find an investment which can yield a net 10% return.
Your access bond is a worthwhile place to save your hard earned money.
When you retire one day you have two basic options when choosing a pension. You either hand over your retirement fund to a product provider and let them provide a pension for you for the rest of your life or you can choose to manage your own fund through your retirement. Lets explain the two options:
The Life Annuity This is a structured pension based on the amount of money you have accumulated and your life expectancy. The product provider will offer you a pension for the rest of your life. Should you die sooner than estimated then the balance of your pension capital goes to the pool. You can take out a guarantee on your pension for a period. The longer the period the lessor the pension. If, for example, you choose 10 years, then the pension will be lower, but should you die, say in year 8, then the remaining 2 years of pension will be paid to you nominated beneficiary.
The Living Annuity
This pension allows you to invest into a wide choice of funds. You decide on your pension by making a choice between 2,5% and 17,5% of the value of your fund. When you die the investment passes onto your beneficiaries. The big risk is drawing down a pension at a higher rate than the investment performance. If you achieve, say, a 10% return and draw down a 12% pension, then you effectively are eating into your capital which will result in your pension drying up a lot sooner. You need to monitor your living annuity carefully, constantly assessing the returns and the percentage drawn down.
So which one should I choose?
If you are convinced that you will live longer than the average, a life annuity is probably the better consideration. The guarantees on the pension need to be studied and understood before committing. Ultimately, the life annuity provides certainty for your retirement around which you can plan more effectively. However, you essentially give the assurance company your money and compete with the statistics of life expectancy.
If you want control of your pension and are prepared to keep involved with the investment during your retirement years, then the living annuity is your better option. The pension drawn should be carefully considered along with the funds chosen. Be realistic about your expectations of returns taking costs into account as it is the net value that matters.
Depending on your total provisions available at retirement you could consider a combination of these options. Your choice of pension is a very important financial decision to make and you should seek advice from a professional financial planner to help you find the appropriate solution.