How to make the most of it
With Prime at 10.5%, and likely to rise further this year, your returns from cash (and bonds) are going to be better than they have ben for many years, and will almost certainly be less volatile than the stock market. So how do you take advantage of this – but not lock yourself into something for years?
- Maximise your interest tax deductions. Your annual tax certificates (IT3) will be coming in over the next few weeks – are you maximising your R30k annual deduction? If you are, look at tax free savings accounts (max R30k contribution pa).
- Use ‘cash’ and ‘bonds’ to moderate your portfolio if you need to preserve your capital in your investments. You may also want to moderate your portfolio and still get a decent return if the wild fluctuations of the stock market is making you ill.
- Pick a savings pocket that gives you decent interest for your emergency fund. Shop around – you might be surprised how much they vary. If you’re a frequent traveller having a Visa and a Mastercard might be prudent – in some countries you cannot rely on both being available all the time. Factor that into your choice of savings account.
- Kill as much debt as possible, starting with the most expensive – credit cards and personal loans. Interest rates on these products run over 18% – you’re not going to get that guaranteed returns anywhere else. Sure, you aren’t ‘getting’ interest but you’re saving having to pay it – and you don’t have to pay tax on it! Your bond is the last of the ones to throw money at, because it is the cheapest, but once the others are gone, a great place to ‘invest’ your money. Wealth is what is left when you have ‘consumed’ your income. It makes no sense to pat yourself on the back when you add interest to your income when it is consumed by interest you’re paying over the odds for on the other side of the equation. Focus on the bottom line, your wealth, not your income.
- If you absolutely have to move house, be very careful about the size of the bond you take on. Will you be able to afford it if the interest rates rise 3, 4, 5% ? Moving house frequently is one of the biggest wealth killers – examine your motivations really carefully. Maybe you need a few sessions with a shrink or coach and not a new house.
- New cars are another black hole that can suck the life out of your wealth – the same things apply to them as to houses. The biggest favour you can do your long-term wealth is to separate your ego from cars, houses and keeping up with the Joneses.
- Should you fix your bond? Tip – when financial institutions start offering to fix your interest rate ( always above the prevailing rate) you can bet your bottom dollar they are about to drop. Right now, that ship has sailed.
- If you’re retiring, consider taking out a ‘life’ annuity and not a ‘living annuity’. This is even more pertinent if you’re single and it doesn’t matter that the investment dies when you do. A ‘life’ annuity gives you certainty on your income that a ‘living’ annuity cannot. The interest rate that you ‘buy’ your life annuity at stays with you for life. Those pensioners who took out life annuities when interest rates were at 20%+ are laughing today. Factor in inflation though – it costs you more but rampant inflation can very quickly erode that fixed income.
Action: This is a good time to focus on the ‘asset allocation’ of your investments, maximise your tax deductions and mitigate some of the volatility in your portfolio if you need to preserve that capital in the short term.
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Author Dawn Ridler ©
The Passive revolution
All over the world investment fees have fallen substantially, not just as a result of lost trust in investment bankers’ post 2008, but with the massive increase in the use of ‘passive’ funds that use cheap computers instead of expensive asset managers to structure long term portfolios. In other words they just follow what the stock market is doing and don’t try and get clever and ‘beat’ the market. The losers are the ‘mutual funds’ what we call Unit trusts or collective investments here in RSA. Gone are the days when asset managers could get away with fees of up to 3%. Passive investments usually come in below 0.5%, and some even lower than 0.3% and we haven’t seen the bottom yet. Why are we in SA dragging our heels to keep up with this global trend?
One answer could lie in our much higher inflation for the fees to hide behind. If you take 3% off a 10% growth you’re still getting 7%. Factor in inflation of 6% and the real growth is only one percent. It looks very different to taking 3% off a 5% growth ( which is in line with the kind of growth they have been experiencing in the West), their inflation is still around 1%, so the nett effect is the same – but the perception by clients is way different. Basically we have been hiding behind double digit growth. Investors are happy to share in times of good growth, but when things swing down they aren’t quite so magnanimous.
The trend to lower cost passive investing has already started in earnest and clients that are following offshore trends are (rightly) insisting on these lower fees, especially for long term investments like retirement funds.
Performance fees – which are essentially hidden – are another bone of contention and the government has woken up to the problem and started to demand ‘clean’ pricing (without the dirty performance fees) for retirement funding, starting with the Tax Free Savings accounts. Performance fees have a number of issues. Firstly they are imposed on future performance based on past performance. In other words, new money coming into the fund has to pay the fee despite not having enjoyed the return in excess of the benchmark. Secondly, some collective investments build their own benchmark – making it impossible for you to compare apples with apples. It’s like doing your own performance review.
Longevity isn’t for sissies
Every year we get a greater understanding of what shortens or prolongs life. Medical research finds ways of extending life and life expectancy increases – to universal celebration. This increase in life expectancy has to be funded in the retirement years. In countries that have decent government sponsored pensions this is causing a severe problem, exacerbated by the slowing birth rate. In effect in those countries they are using pension contributions from the young to pay the old, because estimates made decades ago as to how long people would live were way out. This is all going to implode one day.
In South Africa, where most working South Africans will have to make their own provisions for retirement, and cannot rely on the government safety net, this problem is right on our doorstep. The retirement models that many financial planners use, still assume that we will live maximum 20 years past retirement age of 65. In other words 85. These models assume total capital consumption because preserving capital makes the required savings ratios out of reach for most struggling families.
Unfortunately it is much more realistic to assume that you will live 30 years past retirement. There is another growing trend that is going to impact this even more. Families are postponing having children into their thirties, and even their forties. This means they will have dependants will into the traditional ‘accumulation’ years, perhaps right to the edge of retirement. It’s an uncomfortable fact that children put a significant dent in your consumption and makes it very difficult to top up retirement savings. If couples that delay starting family are doing that high accumulation and retirement saving before children, then there wouldn’t be an issue, unfortunately most couples are consuming much of that income on travel, leisure and lifestyle assets. It is going to take 20 years for that problem to become really apparent, but if you fall into that demographic I recommend you sit down with your financial advisor and plan out a happier outcome. The good news is that the proportion of your income you need to put away is going to be fraction of what it would be in your fifties.
Wealth is what is left after you have consumed your income. So it is simple, if you want to increase your wealth, increase your income or decrease your consumption.
Weapons of mass wealth destruction
In terms of the regulations in financial advisory (the FAIS act), every advisor is obliged to determine the ‘risk profile’ of their client. Many advisors and brokerages have interpreted this to mean a canned questionnaire, now decades old, originally established by certain insurance providers. If you’ve ever taken out an investment policy with a broker you’re probably familiar with the form. There is increasing concern that this questionnaire is used as a blunt instrument, mostly for ass covering if everything goes pear-shaped. Even at the Financial Services Board it is recognised that thought and care needs to enter the equation too.
The reason these profiles are required is that rogue brokers in the past sold high risk investments to pensioners who lost all their money. Is the current format going to fix the problem? I don’t think so, it I time for a rethink.
I have made no secret of the fact that I think these questionnaires are dated, and in the hands of an inexperienced broker can be a weapon of mass wealth destruction. What have questions on short-term insurance excess got to do with investment risk appetite today? If a client has a decent emergency fund, but actually has a conservative investment profile, the fact that he or she takes a higher excess because he or she can afford it, is irrelevant. Asking questions like “Would you rather invest R20k, and potentially grow it to R50k or maybe lose it all” or (in the other box) “Grow it to R25k, but not lose anything” – is probably going to skew the results to gamblers and others.
Interestingly robo-advisors use a variation of the risk profile questionnaire to place their clients into funds, but in the US they are coming to realise that this does not constitute ‘advice’.
Investing without a goal or objective
I think most of us switch off when we are admonished by the media, advisors and especially government to ‘save, save, save’.Ironically, if we really all did it, Western economies would be in a whole lot of trouble. Up to 70% of the GDP in the ‘developed’ world is made up of consumer consumption. In the East, governments like China are trying like mad to stop the populace saving so much and start spending. We all know that there is a ticking time bomb out there, especially in countries like South Africa where there is no real ‘pension’ or welfare safety net to speak of. Instant gratification is rife, from the ultra-wealthy to the poor, facilitated by easy credit. Retirement seems like a long way off, and we have plenty of time to catch up (or feel it is too late). We might mistakenly believe that the thousands we’re ploughing into our mortgage is actually an investment (don’t believe me, read HERE).
Part of the problem is that investment is often compulsory – it is deducted from the salary and it is the price of accepting the job. In effect, it becomes a grudge saving. It is little wonder then that 90% of provident and pension funds are cashed in when someone moves job. The huge backlash from Cosatu and workers when it became apparent that the government was hell-bent on preserving the retirement funds was to be expected (exacerbated by the misinformation that they would lose those funds altogether). Hopefully compulsory pension and provident preservation will come sometime – the cashing in of compulsory savings like this will result in a welfare time-bomb in the future. The State pension is R1350 a month, not even close to a living wage.
Retirement funding is usually the biggest ‘investment’ we need to make on a monthly basis. Believe it or not, if it is a compulsory deduction they are doing you a favour. A long-term objective is always the hardest for your brain to wrap itself around. Retirement annuities that penalise you for early termination act the same way – but that is entirely incidental. Those penalties are there because they have paid upfront commission to brokers, it has nothing to do with helping you. The one thing retirement annuities get right, that group pension and provident funds don’t, is that you cannot withdraw from it before age 55.
After the very nice bull run since 2008 that should have seen a doubling or tripling of an investment, you’d be forgiven for thinking it is going to last forever. The debt crises of 2008 left deep scars on the emotions of most investors who saw 30% or more of the capital in their investments evaporate. Just prior to the crash of 2008 there was a feeding frenzy on the stock exchange – a lot of that from individual investors. The smart investors were already starting to sell out of stock portfolios in Nov 2007. What I am seeing now is much of the same sort of behaviour, especially from individual investors, and it is time to take a step back and make sure you’re not putting those hard-earned investments at risk.
Buy high, sell low : This phenomenon can be explained by the new acronym, FOMO. Fear of missing out. The stock market breathes in and out, that is just in it’s nature. Sometimes it hiccups, jumping up and down by a few percentage points for no reason. Occasionally, just like us, it heaves a heavy sigh and sheds some 10, 20, 30%. It’s going to come sooner or later and the longer the bull-run continues, the probability grows. When individuals wake up to the fact that everyone in the stock market has doubled or tripled their money, FOMO kicks in. More often than not these ‘inexperienced’ investors will buy shares online, get involved in day-trading or (more sensibly) buy ETFs or other trackers – Of course prudently saving stockbroker or advisory fees of 1%. Winning! Those financial ‘nannies’ (like me) might have been as silly as to try and tell you that stocks are a long term (8 yr plus) investment and try and get you to make your investment less ‘aggressive. What! And leave all that money on the table! Then the market turns, and those investors hang on and hang on hoping for a turn around, until they can take it no more and bail.
Allowing greed or fear to rule your decisions: Many people will get to the later years in their life and wake-up to the fact that they have not made enough provisions for retirement and fear kicks in. There are a number of ways to remedy this. You could start saving more – slow and painful but effective. You could lower your expectations for retirement – again painful but hopefully far enough in the future for you to ‘get used to it’. Finally, you could tweak your asset allocation (cash, bonds, property, stocks – read more HERE) so that you get more growth. Painless! Yay! Of course there are limits, both to its effectiveness and prudence. Can you afford to put a 30% hole in your capital in the short to medium term? If you’re 10-15 years from retirement then yes, you can probably afford to make your investment much more aggressive. Less than that? Not so much. Given the choice between a painful and an easy choice, easy is going to win – unless you step in and recognise the actions of the greedy demon whispering in your ear.