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Monthly Archives: January 2017

How to Choose The Right Funds

I would like to congratulate you on your decision to use your tax-free savings account as part of your retirement planning. The biggest saving the tax fee savings account offers an individual is that you pay no capital gains tax when you withdraw money, and having a tax-free income can have a big impact in your retirement years.

The R500 000 that you are currently allowed to invest in a tax-free savings account during your lifetime is equal to investing R30 000 a year for 16 years and 8 months. The good news in your case is that if you plan to retire at age 65, your annual allowance will be invested for just more than 22 years before you start using it. That means it will be compounding during that time, and you will not have to pay any tax on the gains.

In order to maximise your return on your investment over time, however, you need a clear investment strategy to guide your decisions over time. You appear to appreciate this, as you mentioned that you do not want to make emotional decisions about your underlying investment funds.

You also realise that the investment environment has changed since last year. But if we assume that your investment period is nearly 40 years, we would expect things to change regularly over this time.

As a start, you need to write down your profit objective for your investment. You can then design an investment strategy that will give you the best chance of meeting this goal.

I cannot advise you exactly which funds to invest in, but I can give you some things to think about.

Your time horizon allows you the luxury to invest in more aggressive asset classes such as equities and listed property. Investing in these growth assets over a period of time gives you a high degree of certainty that you will beat inflation on average by 7% per annum. If you can handle volatility in the markets, then you can set that as your objective.

The next step is to design your investment strategy to be robust enough to cater for different market conditions. That means being exposed to different drivers of returns.

For example, the Divi index is essentially a value index and will perform well when that ‘style’ is being rewarded by the market. It however will also go through times when it under-performs, such as it did last year.

Similarly, there will be periods when local equity performs well, and other times when international equities deliver better returns. It is worth considering whether you should be always exposed to both, or if you can make informed decisions about when to direct your contributions to one or the other.

An important decision you need to make in this regard is whether you have sufficient knowledge of the markets to handle investments during different market cycles or whether you are prepared to pay a fee for a professional to handle your investments for you.

While crafting this investment strategy is vital, just as important is having the discipline to stick to it.  You should also have a system in place for measuring the effectiveness of your investment strategy over time.

Just bear in mind that great tactics may win battles, but well thought out investment strategies win wars.

Your budget versus your lifestyle

Let’s face it: we all want the lifestyle of our wealthy friends, neighbours or celebrities even when our own lives might be on the right track.  We never seem to have enough, unless of course we decide to change the way we think and how we measure our own success. That starts by living within our means – something that is not an easy decision for most of us to do.

I recently met investors who should have been very well off during retirement as they have managed to save more than R 20 million. Unfortunately, their lifestyle costs are so high that their money will only last for ten to 12 years after retirement.  They need to make drastic changes to their spending habits or retirement is going to be a difficult time for them.

How did this happen?

My sense of these investors is that they earned a great income and never once budgeted to save. Their saving was an accident and something that happened on an ad hoc basis because they never had a spending plan. Your budget is in constant competition with your lifestyle unless you keep it under tight control. Life is about making compromises, but you need to make sure that you take the negativity out of this process and look for positive compromises. What do you really want? Do you want to curb your grocery spending so that you can have one great meal eating out at that fantastic new restaurant? Would you like to send your child to private school or live in the bigger house? Drive the new shiny car or go on a holiday?

You need to decide what makes you happy and spend your money on this. That means you need a budget – something most people don’t have. Once you have worked out what you need every month to cover your lifestyle costs, transfer the difference in your transaction account to another account, where you won’t be tempted to spend it on frivolous items. Hopefully there is an excess in your budget and if there isn’t, get a third party to help you. You are the only one with an emotional attachment to your money and a pair of impartial eyes can help to make you think clearly about your money and to make smarter decisions.

And then you need patience. Once you have decided that you want to take that trip to Italy, you have two choices. You can go immediately and use your credit card or you can save and wait until you have the money to pay for the trip. If you have the cash available; a trip to Italy will cost you at least R 25 000 (as an example). If you decide to pay upfront with a credit card it will cost you between R 44 289 and R 64 843, depending on whether you pay it off in three or five years at an interest rate of 21% per annum. Most of us are able to stomach R 25 000 for such a trip, but R 64 843 is a bit rich. Patience has a real monetary value.

Patience is tested especially when you start to save for retirement. This is usually because we do not have an idea of what retirement will look like. We almost try to avoid it, because it reminds us that we are getting older. If you know where you would like to stay after retirement and what you would like to do with your time, the decision to save for it becomes far easier.

Lifestyle is important; this is how we live every day, but it must fit into your income. So figure out what you can do without to make the things that are really important to you, obtainable.

Tips for Teaching Your Children About Money

For many parents, money is an uncomfortable subject. Discussing finances with your children is either too scary or too personal for many people.

However, a panel of experts at The 2016 Money Expo agreed that this is one of the most important subjects any parent has to manage. Preparing your children for their financial futures is one of the greatest gifts you can give them.

Nikki Taylor from Taylored Financial Solutions said that the earlier parents start on this journey, the easier and more effective the lessons will be.

“For me, it’s about starting them early,” said Taylor. “How do you teach children manners? You don’t wait until they are 15. You start when they are really young.”

Brand manager at Emperor Asset Management, Lungile Msibi, said that even two- and three-year olds can appreciate the lessons of delayed gratification and working towards a goal.

“Start kids when they are young with goal-based savings,” she advised. “If they want a Barbie doll, for instance, show how they can save towards that goal. That’s important because later in life they will understand that you can’t invest if you don’t have a goal.”

As they grow older, you will have therefore prepared them for conversations about investing for the long term. It’s particularly helpful if family members support you.

“When my kids were born I gave their grandparents bank account details for both of them and said instead of filling my house with toys at birthdays and Christmas, please put money in these bank accounts,” said Taylor. “My children still get toys and presents, but they also see the money in their accounts and how it is earning interest. They now get excited at every birthday and Christmas to see who has put money in for them and how much they now have.”

It’s also important to involve your children in how you are saving for their own futures through things like education plans or unit trusts that they will receive later in life.

“I’m saving for different stages of my son’s life and he knows what each of those investments are and what they are for,” said Dineo Tsamela, founder of The Piggie Banker. “He gets excited because he can see what that money means for him – that he will have access to a really great education and that he will have some financial security. He appreciates that money is not just about what it can get you now.”

Msibi said that it’s also important to teach children the impact of the choices they make. She used the example of a child who wanted a new iPhone, but his parents offered him the choice of having them invest that money instead.

“The value of an iPhone in one year or two years diminishes,” said Msibi. “But if your child rather invested that R10 000, it could make a huge financial difference later in life if you give it 40 or 50 years to grow.”

It is also crucial that parents instil a sense of where money comes from.

“You have to teach them the value of work,” said Tsamela. “It’s very important for children to understand that money doesn’t just happen – that there are things you have to do for it to come in.”

Taylor agreed.

“If my kids want anything we negotiate how many stars it will cost, and I then allocate them stars for things like good manners or cleaning a room,” she said. “They ask me why they have to get stars when their friends get things for free, and I explain that mommy has to work for everything she earns, and that’s an important conversation. Because it becomes something they have to work towards, they also have to consider whether it’s worth it or whether there is something else they want more instead.”

Crucially, this is also linked to the values we teach our children. And those values are most often conveyed in how we ourselves treat money.

“What value system do you instil in your children through the way you spend your money?” asked Kristia van Heerden, CEO of Just One Lap. “We should think about how we interact with money and what money can do for us.”

Tsamela added that parents have to think about the lessons they are teaching through how they talk about what money is and why it is important.

“Putting the emphasis on saying that you have to be rich, you have to have money distorts children’s view of how the world works,” she said. “Don’t make money the primary thing. What is primary is fulfilment and that you enjoy your life. Everything else comes afterwards.”

Importantly, parents should consider carefully what they teach their children about what it means to be successful.

“Parents need to teach their children about purpose, resilience, following their dreams and pursuing them relentlessly,” said Nonqaba Stamper from FundBabies. “If they help their children to become the best version of themselves, that is when they contribute to society and make South Africa a better place. When they see themselves as people who can add value, that’s where true success lies.”

What to do with bonus money

A lot of people who get a bonus or once off additional income for whatever reason, tend to ‘blow it’ as you have pointed out. It is therefore a very good idea to try to think of better things to do with the money. I would, however, suggest that you consider not only your immediate or short term needs but also the long term potential of any extra income you receive – no matter how small.

If you have a need for extra monthly income, which might be the case if you are currently using a credit card or overdraft because your expenses are close to or more than your current monthly income, then I support your idea of putting the money in a vehicle that will allow you to supplement your income for the next two years.

A two year term, however, is a very short time horizon for an investment and I assume you intend to be drawing the full amount over the two years. In other words, you will be left with nothing at the end.

If so, you will need access to the money and very little, if any, risk. With these constraints in mind, I would suggest either multi-asset income unit trusts – the top funds produce between 8% and 10% per annum historically – or a bank savings, call or money market account with cash immediately available. These bank accounts produce between 5.5% and 7.5% per annum, depending on the amount.

Let’s use an example and say the amount is R50 000. If you can achieve returns of 10% per annum for the next two years, this will produce an income of R2 307 per month for 24 months before being depleted. At 7% per annum, the monthly amount will be R2 194 per month, so there is only a small difference, which means it is probably not worth taking the extra risk.

The question is whether you actually need additional income or if you are just going to be spending it over 24 months instead of one month. If you don’t really have a requirement for the additional income, you may want to consider investing the amount for a longer term so that it can produce even more for you.

You could consider putting the money into a tax-free savings account or retirement annuity (RA). By contributing to an RA, you would be reducing your taxable income. This means you could get something more back from the South African Revenue Service next year, depending on what retirement contributions you are already making.

Let’s use the same R50 000 we used for the example above and assume that you are below the maximum deductible contributions to your retirement funding. This is currently 27.5% of your remuneration or taxable income, or R350 000 per annum, whichever is lower.

Let’s also assume that you are in a 36% tax bracket. If that is the case, you would get an additional R18 000 back from SARS or have to pay in R18 000 less for income tax when you submit your next return. In other words, you receive your R50 000 dividend, you invest it into an RA which results in you having an extra R18 000 next year, and the R50 000 also grows until you retire. You can only access the money in an RA once you turn 55.

The tax free savings account option wouldn’t allow you to deduct contributions for tax, but it also doesn’t tie the money up until retirement. Taking into account that growth and income in the investment is not taxed, you can benefit hugely if you think of it as an additional retirement savings plan.

Let’s say that you have 20 years to retirement. If you put R30 000 per year into a tax free savings account and achieved growth of 10% per year, you would have an additional R1.7 million at retirement with no tax consequences at all. R1.1 million of that would represent gains which would otherwise have been taxed. You can also draw this money out at any time if you have a need for it, so it has the benefit of being an ’emergency fund’ for added security.

The idea is that whenever you get a little extra, take that amount and make it work even more for you, and so improve your position over time. You are thinking along the right path but a two year term doesn’t give you too many options without substantial risk. If you can think longer term, you would be surprised at how much more those dividends can do for you.