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Is ‘Lifestyle Creep’ killing your wealth?

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Do you recognise this in your budget?

Lifestyle creep a hidden effect, especially in higher inflation environments like ours. Basically, it is the continuous upgrading of one’s lifestyle and increases in consumption in REAL terms as our incomes increase. I have capitalised REAL for a very good reason, it is the actual increase minus inflation. In other words if your increase is 6% and inflation is 6% then the real growth is zero. When it comes to after-tax income though, it may even be negative. This is usually a problem when it comes to the big lifestyle expenses, like houses and cars. I have gone into the wealth implications of both these purchases HERE, so I am not going to repeat myself, but if you ‘upgraded’ your house or car because you’ve received an increase or promotion, then read on…

What has tax got to do with it?

Tax is levied on a sliding scale in groups called “Income brackets”, have a look at the graph below which is for the 2017/2081 tax year.
2019

Let’s look at the middle of the range of income tax bracket, which is where most of the lifestyle creep occurs: In the tax year ending 2016 the range was R393201 – R550100 the marginal rate was 36%, in the year ending 2017 it was R406401 – R550100 and this year ending Feb 2018 it is R410,001 – R556000 tax rate 36%. it’s all 36% so there will be no tax rise? Not so fast…

In 2017 this translates into a 3.35% movement in the bracket when inflation was around 6% and 2018 it was even worse, with a minuscule 0.88% movement when inflation was around 6%. In other words, the government is deliberately pushing your income into a higher tax bracket every year. In effect, therefore, in the 2016/17 tax year, unless you had an increase above 9.35% you had no real increase in take home pay. In 2017/18 it would have to be over 12% to have a REAL increase in take-home pay. If you feel that you’re poorer, that is why.
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Before you go… Emigration and Investments

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Before you emigrate, find out how your investments will be impacted

Whenever uncertainty increases, South Africans start looking at how liquid they are if they want to get up and go, and this is one of those times. Noises from the government recently are that they want to ‘document’ emigration to prevent it (a complete non-starter and just more jobs for pals). Emigration of educated youngsters has been happening for decades, and because they have very little in the way of assets so do not have ‘financially emigrate’. Those stats are ‘hidden’ and become part of the brain drain because those youngsters just cannot find the jobs they want here. For older and more established South Africans though, emigration as opposed to a leave of absence to work outside the country, comes with a myriad of investment or disinvestment decisions that need to be made. This is also known as official or financial emigration.

Capital gains tax: One factor many emigrants do not consider is that emigration triggers Capital Gains Tax (CGT), whether or not you leave your investment or property here. If you merely work elsewhere but remain an RSA resident (as many people do if they work in Dubai for example) then this does not apply. Be aware though that the government is itching to bring those ‘tax-free’ earnings into the RSA tax net. Capital Gains Tax was initially introduced to replace Estate Duty, but I am sure it of no surprise that not only do we have both but CGT is creeping up steadily and is now a nasty corroder of any investment.

If you’re thinking of emigrating, and if you have a large property or stock portfolio, I recommend you make yourself familiar with CGT. You can get a simple 15 page brochure on it HERE. There is, of course, the 800+ page brochure available too if you’ve run out of sleeping pills. Working out CGT is not simple and is a multistep calculation, as you will discover if you read the brochure, so I recommend you get your tax advisor or Certified Financial Planner ® to do this for you (your broker probably won’t be able to help you). There are 2 aspects to Capital gains, the ‘inclusion rate’ (the percentage of the capital gain that is used in the calculation) and your marginal tax rate.


Flexible investments
: These are relatively easy. Either you leave it or sell out and use your Forex allowance to take it out – either way, you’ll have to pay Capital Gains Tax on Shares or Unit Trusts. If you leave it here, you’ll have to keep submitting returns and paying tax, but if you move to a country that has a tax agreement with RSA, then the tax paid here will be a credit on the other side so double tax is not paid.
Pension and Provident preservers: These are put in place (with the help of a financial advisor) in order to preserve the tax status. If you withdraw from that fund (one withdrawal before retirement (age 55) is allowed – it can be the full amount) but is taxed according to lump sum withdrawal tables. An R22,500 lifetime tax-free amount, and thereafter a sliding scale starting at 18% and going up to 36%. If you officially emigrate, Pension Preservers can also be left and handled at retirement or age 55 –but that involves substantial administrative PT, especially if you do not have an RSA bank account. Hint, keep one in place if you go this route, even if it is a cheapo like Capitec. Depending on the size of the Preserver, Tax could take a sizable chunk out of your investment. You still have the option of never retiring from it, in which case it will go into your estate.

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So you want to be an entrepreneur?

in Behavioural finance, Business Assurance, Financial Advisory, Financial Plan Leave a comment

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Hidden traps waiting for unsuspecting entrepreneurs

Entrepreneurs, especially if they haven’t been cursed with climbing the corporate ladder or an MBA, have some unique challenges when navigating the field of personal and small business risk and finance. Perhaps it’s that fearless spirit and boundless confidence that will guarantee your success, but “jump and build your wings on the way down” sometimes ends in a bloody mess at the bottom. A bit of homework on wing design and jumping with the right tools would have prevented that – and the same goes for that entrepreneurial venture you dream about.

Test your idea: Unless you’re buying a franchise, a new venture usually starts with an idea, and with a product (which could be a service of course). It is important to iron out at least some of the bugs before you sink too much money into the venture. Who is your target market? What are their expectations? How much are they prepared to pay for the product? What after sales service do they expect? How often will they buy your product? How can you retain their loyalty? Don’t let a poor product sink your venture before it even starts.

Everyone needs to ‘maak’ a plan: Seat of the pants ventures or bootstrapping your way through the early years probably works a charm in your early twenties when you don’t have obligations, not so much later on. One of the biggest mistakes entrepreneurs make is to buy into the fallacy that business plans, financial plans, marketing plans, business qualifications are all bureaucratic nonsense designed to kill your dreams. Dreams and visions are all very well, but unless you know what your “break-even” is for example – and when you might achieve that dream – then it can become a nightmare. The good news is that all this information is freely available on the net, in books and online courses. Do all that homework and put your plan together before you leave your day job. If you’re ‘between jobs’ then use the time to do this homework, but keep looking for a job, even if it as a temp, Uber driver or from your rented room while you rent out your house. Money to launch your venture is hard enough to come by without spending it doing the homework and learning basic business skills.

Who are your clients going to be and how are you going to get them? This is key to any venture’s success. If you’re starting a business very similar to your ‘day job’ tread carefully, if you cannibalise their clients or copy their products, you might spend a chunk of your change in court. Brushing up on social media marketing and building your potential network takes time and trail and error as you find out what works and what doesn’t. You can also use social media to test your product or use free tools like Survey Monkey

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Investing Offshore – First Ask Why

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Offshore Investing – First ask why -(then where and how).

Whenever SA Inc has a wobble, South Africans worry that we are going the same way as our neighbours to the north and look to moving some of their nest egg offshore (or moving themselves out altogether). It’s all very well to dismiss this as a kneejerk reaction, but those fears and doubts are very real and personal, so let’s take a look at the pros, cons and possible pitfalls.

Whenever you make a new investment, and an offshore investment is no exception, it is very important to determine the end-use objective of the investment – that will be the primary determinant of how it should be invested. To put it very simply, the objective will determine the timeframe and the need to protect or grow capital – and the asset classes that should be used to achieve this. Short-term investments usually need to be liquid and preserve capital, so cash and bonds are used. Long term investments, on the other hand, can have less liquidity, and ride out the cycles in the stock market to optimise the growth of that capital over a decade or more.

Before we look at the different investment objectives, let’s look at some of the realities of offshore investing. In all investing (local or offshore) there are 4 basic asset classes: Cash, Bonds, Property and Equity. Currency mixes everything up! Basically, it acts as a ’multiplier’. Think of it like this:

  • Rand depreciates and your offshore investment grows at about the same rate – effectively (in Rand terms) your investment has ‘doubled’.
  • Rand depreciates but your investment shrinks – these counteract each other and your growth is flat.
  • Rand appreciates and your investment shrinks – you will get a double downward whammy.

 

Another factor that will impact your offshore investment is inflation. In the West, inflation is so low that disinflation is a very real threat. Interest rates are used to keep inflation under control (the ‘monetary policy’ of central/reserve banks), and these have been in the low single digits for over a decade (and in some instances have actually gone negative). The UK has seen a ‘welcome’ bump up in their inflation, but that is thanks to GBP depreciation as a result of Brexit. Cash and Bond returns of your offshore investments will probably be minuscule, and after bank or investment fees could well be negative. This puts you in a quandary if you want to preserve your capital and get it to grow even at just inflation without risk.  Although the Western stock exchanges have been doing quite well (especially in the last 6 months) the days of double-digit stock growth are rare post-2008.

Currency values do not move rationally, they are the playground for day traders, and the Rand volatility makes our currency one of the favourites for these gamblers. Having said that, the gradual depreciation of the Rand over decades is largely due to the large inflation disparity between us and the West. Even at our 6% inflation, we are consistently 4% above developed nations, so it is can be expected that we will continue to depreciate by this difference over the long term.

Let’s look at the different ‘objectives’, and how to structure your investment accordingly:

Emigrating: If you have made this decision, then partner with someone who knows the Reserve Bank regulations so you can start moving your money out – the sooner you start it the better. If you formally emigrate (as opposed to leave and live or work outside the country for a while) then this is considered a Capital Gains Tax event on all your assets, even if you leave them here. This tax will be due on investments, and property (especially property that is not your primary residence). If you are not formally emigrating but want to top up your retirement bucket by working in a tax-free/friendly country, beware of the changes in regulations that are on the cards which will bring you back into the SA tax regime and will be a game changer.

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The absolute basics of managing your wealth

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Never abdicate your responsibility

Personal finance can be overwhelming and complex, but if you want to partner with an advisor to help you protect and grow your wealth there is a bare minimum you need to know so you can assess whether your wealth is invested properly and you have the factors you can control on your radar. There is nothing more dangerous than being ‘unconsciously incompetent’ – not knowing what you don’t know.

Here are the handful of numbers you must know (in order of priority):

  • The “repo” (repurchase) rate (currently 7%), prime interest rate (usually 3.5% above repo rate, now at 10.5%) and the interest rates of all the loans, mortgages (usually close to prime), credit cards ( as high as 18-24% at the moment), car loans etc. that you have. Why? This will illustrate which debt must be paid off first. Read HERE for more on ‘Smart debt’. This will also give you a benchmark that you can rate your investments against.
  • The inflation rate (currently 6.3%, the top end of the target range is 6%.) If you know this number then you can do a simple calculation on how well your investments are doing. If your investments don’t keep up with inflation then the ‘purchasing power’ of your investment erodes. The actual rate of return, minus inflation, gives you the ‘real’ rate of return which is what you should focus on, not the bottom line.
  • The difference between “Interest” (money market), “Yield” (bonds but taxed as interest), “Dividends” (from shares) and “Capital growth” (shares and property). These all grow your wealth but are very different, have different risks and are taxed differently.
  • The very basics of your annual budget. Your net income, fixed expenses, investments, variable expenses (groceries, entertainment, clothes, fuel, cell phones etc) and ‘disposable income’ (what is left over.) If you ever apply for a loan or mortgage you’re going to need these numbers anyway. Disposable income should never be zero. If money burns a hole in your pocket, put it out of the way on payday, say into a call account. Living within your means and continually saving is the key to long-term wealth.
  • The age at which you (realistically) want to retire. This is the line in the sand where you essentially stop investing and start drawing down on your income.
  • What your annual budget will look like at retirement. Once you have your present day budget, this is easy. You take out things you won’t be doing at retirement – mortgages, school fees, debt and add back things you will – travelling more perhaps. You or your advisor will now be able to project how much you will need in investments to retire and live on your income until at least 95 or 100 years old.
  • The monthly contributions you need to go into your investments to retire on your due date, at your desired income. Knowing the actual capital amount you need (above) is useful 10 years out from retirement, longer than that it is pretty meaningless, focus on eating the elephant one month at a time.

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Financial Worry

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Worry – paying for an outcome now that may never happen.

In uncertain times, like now, it is very natural to worry about the future, specifically to worry about your future financial security. Worrying is highly stressful and pretty useless, but one of the best ways to counter it is through action and knowledge.

One of the most useful things you can do is to understand what you can control and what you can’t. You can’t control the economy, interest rates, exchange rates and political climate. Sure, you can chafe against it, write letters, sign petitions or protest, but the bulk of your energy should be focussed toward things you can do to protect your wealth and your lifestyle.

Knowledge is power, I am not saying you need to know everything, but there is a certain amount of knowledge you need have so that you aren’t ‘unconsciously incompetent’ – when you don’t know what you don’t know. That is the most dangerous place to be. We all know that being unaware of a law is not going to save you when you get to court, and when it comes to wealth it is just as important. You don’t want to get 5 years out from retirement and realise that you’re going to have to keep on working into your 70s and 80s. Never abdicate the full responsibility for your wealth to anyone – not a spouse, financial institution, broker or advisor.

Always invest in yourself, not just by saving and investing what you earn, but in your knowledge and skills too. To have longevity in the economy, whether you work for yourself or someone else, you need to build the brand “You”. Don’t be sucked into by superficial things though – expensive clothes, cars and houses only impress the shallow and wanna-bes – and why do you care what they think?

Know your limitations. Even if you’re a knowledge accumulating machine, there is going to come a time where you are going to need help – or go the whole hog and become that professional. There is always going to be a medical condition that needs a specialist, a legal situation that needs a lawyer or a sabotaging behaviour that needs a coach/shrink. Sure, knowing the basics is a huge help and can save you a lot of money, but it is not a weakness to seek help, it is just smart. When it comes to managing your wealth, the days of ‘free’ advice from your broker is dying fast. Just like you can get accounting help that varies from a bookkeeper to a CA, the same applies to the management of your wealth, the Chartered Accountant equivalent in Financial Advisory being a ‘CFP®” (Certified Financial Planner)- a professional, internationally recognised designation.

While we cannot control the economy or politics, we can control most of our personal wealth and earnings potential – even in the most trying times. Being a Chicken Little (“Oh! Oh! The sky is falling on my head, I must go and see the King”) is negative, destructive and unhelpful. It might make you feel better to pull others into your perception of drama, but there are more useful ways to divert that energy. Quite frankly, if you have a Chicken Little contaminating your inner circle, sideline them, especially at times like these where there is so much uncertainty. Now is not the time to make knee-jerk decisions like selling all your investments or emigrating. You need to ‘keep your head when those about you are losing theirs,’ (with apologies to Rudyard Kipling).

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