By: Martin Hesse
Half a grand doesn’t buy you much these days, not even a trolley of groceries; perhaps a dinner for two at a moderately upmarket restaurant, if you choose a cheapish bottle of wine.
Conversely, it’s probably not very difficult to find R500 a month to put aside for a rainy day. Let’s say you’ve given your budget the once-over and found a spare R500 that you can afford to put away month after month for at least five years. As with any investment, you want the best returns at as low a risk as possible, and preferably a savings or investment vehicle that is flexible enough to allow you to deposit extra or, in an emergency, withdraw your money at short notice.
You may be immediately attracted to the obvious safe banking options (or “solutions” as they are happily called in bank-speak), such as a debit order from your current account into a separate savings or notice account. But these generally offer very low rates of return. Looking further afield, you should find ways to earn a better return without necessarily taking on more risk.
At the very least, you want to beat inflation, which eats into your savings relentlessly and mercilessly, and which can result in an alarming drop in the value of your money over time – just how alarming is illustrated in the following example:
Assume you want to save up for a specific consumer item that today would cost you R30 000. If there was no inflation, your R500 a month over five years would exactly pay for it – you could stash the money under your mattress.
But assuming a constant annual inflation rate of 4.2 percent (the figure for year-on-year CPI inflation at the end of April 2011), the item will cost you R36 852 five years from now. You would have to save for more than an extra year to make up the shortfall (by which time the price would have risen again, to over R38 400!).
Putting your cash under the mattress, you might think you could keep up with inflation by increasing your contributions by the inflation rate (4.2 percent in this example) each year. Your contributions would look like this (the figures have been rounded off to whole rands):
Year 1: R6 000 (R500 a month)
Year 2: R6 252 (R521 a month)
Year 3: R6 515 (R543 a month)
Year 4: R6 788 (R566 a month)
Year 5: R7 073 (R589 a month)
Total: R32 628
It may come as a surprise that you are still not close to the R36 852 you’ll need. This is because not only are your yearly increases lagging behind inflation, but you are accumulating your target amount over a long period (five years), whereas inflation is taking its toll on the entire cost of the item from the very beginning. In fact, you would have to increase your monthly amount by around double the inflation rate each year to have enough to buy the item after five years – or save a constant R614 a month.
So, for saving to be worthwhile, you need not only to earn an above-inflation return but you also have to increase your contributions each year so that the value of those contributions doesn’t diminish. However, for ease of comparison, we’ll keep the contributions at a flat R500 a month.
It’s time to move out of the bedroom and see what is available to you – and compare returns, risks, costs and accessibility. The break-even figure to beat inflation is R33 365 – that’s what you would save at a 4.2-percent interest rate, equal to the inflation rate. All bank rates and costs are quoted as at May 31, 2011, and it is assumed that the interest rate and inflation rate remain constant over the five years. Bear in mind, though, that we’re at the bottom of an interest rate cycle and inflation is rising, and interest rates are likely to rise too.
Only products that fit the investment criteria of R500 a month for five years have been reviewed – there are various other products for investors with larger amounts, for longer-term savings, and for lump-sum investments.
Also, you have to consider tax. For the 2011/12 tax year, you pay income tax on interest of over R22 800 a year if you are under the age of 65 – this means that you will have to invest more than R456 000 at five percent, or R228 000 at 10 percent, to begin paying tax on your returns. Also, dividends on local equity investments are currently tax-free but will be subject to tax from the 2012/13 tax year.
You are also liable for capital gains tax (CGT) on any capital gains that you make when you sell or surrender your investment. For the year, your first R17 500 is tax-free and you pay tax at your marginal rate on 25 percent of the rest of your gains. Note that these are discretionary, medium-term savings – the options presented should be considered only after you have fulfilled your long-term financial obligations, such as being on track to save enough for your retirement and saving for your children’s education.
Except where otherwise indicated, the information is from the websites of the relevant finance houses.
1. SHORT-TERM DEBT
Before you start looking at investing money, you need to look at your debt, because, as any financial adviser will tell you, that’s the first place you can score: what you pay in interest rates on debt is normally a lot higher than what you receive in interest rates on savings. First eradicate any debt on your credit card account and your retail accounts, because they usually charge the highest interest – often around 20 percent a year.
While the interest rates on credit card debt are generally high, if you use your credit card account as a savings vehicle, the rates on a positive balance are zero or very low. On ordinary credit cards, Nedbank offers zero percent annually, Absa 0.2 percent and First National Bank (FNB) 0.25 percent to 0.5 percent. Standard Bank has tiered rates, from 0.4 percent to a more respectable (but not inflation-beating) 3.3 percent on an amount over R20 000.
2. LONG-TERM DEBT
Another way to put your half-grand to good use is to channel it into your mortgage bond.
By putting the money into your home loan account, you are, in effect, saving at the rate of interest of the loan, without paying tax on the interest saved, which is almost certainly more than you’d be guaranteed anywhere else. (You might make more in a high-risk investment such as an equity unit trust, but it would be a bit of a gamble over five years.)
Absa Bank has kindly done the calculations for the following example: If you have 15 years remaining to pay back a home loan of R500 000, your monthly repayments at nine percent (the prime rate at the end of May) would be R5 071, and after five years the balance on the loan would be R402 393. If you upped your repayments by R500 to R5 571, your balance after five years would be R359 759, a difference of R42 634 – far better than your savings with any of the interest-bearing investments mentioned below. If you have an access bond, Absa says, you would have access to what you have paid in advance, subject to the contract terms.
If you continued putting R500 a month into your bond, you would pay it off after 11 and a half years and save nearly R80 000 in finance charges.
3. SAVINGS ACCOUNTS
Most of us have a bank account for everyday transactions, so opening a separate savings account into which to transfer R500 a month is certainly an attractive option as far as convenience goes – except that most banks’ savings options fall far short of what is needed in the way of returns.
* Standard Bank’s PureSave, Nedbank’s JustSave, FNB’s Simply Save and Absa’s Money Builder are simple, flexible savings accounts. You can deposit or withdraw money at any time, and they generally attract no charges if you are only depositing money and not using the account for day-to-day transactions. All have tiered interest rates according to how much is in the account, so you progress to higher rates as your savings increase: they are 0.25 to 2.3 percent (FNB), two to 2.75 percent (Standard), 1.35 to 3.90 percent (Nedbank) and 1.3 to 3.90 percent (Absa). None would give you an above-inflation return on an investment of R500 a month, so in effect you would be losing money.
* One bank, Capitec, offers a daily savings account with substantially higher rates, which will give you a positive after-inflation return: six percent on amounts under R10 000 and 4.75 percent on R10 000 or more (the more money in your account, the lower the rate, unlike other banks). For all Capitec banking, you first need to open a Global One transaction facility, on which there is a R4.50 monthly administration fee. If you save R500 a month, for the first 19 months, while your balance was under R10 000, you would earn six percent, and you’d earn 4.75 percent thereafter, giving you a total of R33 590 (net of the monthly fee).
* Standard Bank has an innovative savings product called ContractSave. You must deposit a minimum of R100 a month for a year, but thereafter it is as flexible as the bank’s PureSave option. There are no fees if your debit order is from a Standard Bank account. Interest is 3.5 percent on less than R10 000 and four percent on more than R10 000, and you get a bonus of between 0.5 and two percent a year, depending on how long you have been saving. Standard Bank’s online calculator shows you would have R34 695 after five years.
* Postbank, the Post Office’s banking facility, has an inflation-beating account, Bonus Save, whereby you choose the amount you want to save monthly and the term – up to 60 months. Once these parameters are fixed, a penalty applies if you break the contract. You earn bonus interest at the end of the term if you have fulfilled the conditions. Over 60 months, the account offers annual interest of 4.5 percent plus a 0.5-percent bonus, which equals five percent a year. Your final amount would be R34 144. There are no charges on your account.
4. NOTICE DEPOSITS
Notice deposits are relatively flexible in terms of depositing money (some banks specify a minimum balance of, say, R1 000 and minimum deposits of, say, R250), but you must give a defined period of notice to withdraw what you have saved. This limits your accessibility, which is bearable only if the interest rates are worthwhile.
* Standard Bank’s 32-day notice deposit offers tiered interest of zero to 3.5 percent a year, depending on the amount invested. Nedbank has a minimum investment amount of R1 000, and interest tiered up to 3.25 percent a year. At Absa, the minimum deposit is R100 and rates are tiered from 2.5 to 4.2 percent. And at FNB, the rates are tiered up to 2.55 percent a year. As with the savings accounts, you would not get an inflation-beating return.
* Bidvest Bank offers a welcome 6.3 percent annually on its 121-day notice account, but the minimum balance is R5 000. Here it would be worthwhile to use another account to save until you reached R5 000 (after 10 months), and then transfer your savings to the 121-day account. Assuming a rate of three percent on your pre-R5 000 savings, your total savings after contributing R500 a month for five years would be R35 072. The drawback is that you have to give four months’ notice to access your money.
* Absa’s TargetSave is similar to a normal 32-day notice account but requires a minimum monthly deposit of R100 for six months. Interest is tiered from 3.2 to 3.65 percent and there is bonus interest of between 0.25 percent and 0.75 percent after six months. Absa has calculated that you would have R33 451 at the end of five years.
5. FLEXIBLE FIXED DEPOSITS
Fixed deposits are designed for lump-sum savings, but a couple of banks offer more flexible arrangements that allow you to make multiple deposits over a fixed period.
* FNB’s Flexi Fixed Deposit requires a minimum deposit of R100. You can deposit more at any time, but withdrawals are limited to two of not more than 15 percent of your savings. There is a fixed term of three or 12 months, which you can then renew. Interest is tiered at 2.25 to 4.25 percent. Unlike a regular fixed deposit, where the interest rate would remain fixed for the investment term, the rates fluctuate in line with general interest rates.
* Capitec offers a fixed-term savings plan with multiple deposits for clients on their Global One facility. You can deposit money when you like but cannot withdraw anything before the term is up. Interest rates are fixed for the term (six, seven to 12, 13 to 18, or 19 to 24 months) and range from 6.1 to 6.6 percent for amounts in our investment range. Taking an average rate of 6.4 percent, and deducting the monthly R4.50 administration fee, the final savings figure would be R34 947. Bear in mind that, because the interest rate is fixed for the investment term, you would lose out if the rate had to rise.
6. SUBSCRIPTION SHARES
One small bank, GBS Mutual Bank based in Grahamstown, offers a unique – and highly competitive – savings scheme of a type that used to be popular in South Africa in the days of building societies. The bank has branches in Port Elizabeth, Cape Town and Port Alfred, and agencies in other areas.
With a monthly subscription that starts at R50, you can select a maturity date of between 36 and 240 months. Interest is compounded monthly and dividends are capitalised annually. Redemption notice of three months can be given at any stage after the first 15 months. At maturity, the term can be extended for between 12 and 36 months. This product offers interest of 6.25 percent, which would provide a total of R35 293 after five years. The rate is subject to fluctuations in the interest rate.
7. RETAIL BONDS
Currently, there are two retail bonds on the market for individual investors:
* RSA Retail Bonds, the government bonds available to the public, offer attractive returns on lump-sum investments at almost zero risk. The bonds require a minimum deposit of R1 000, can be for a term of two, three or five years, and there are no costs involved. On May 31, 2011, the fixed-rate two-year bond offered 7.25 percent a year and the fixed-rate three-year bond 7.50 percent a year. (There are also inflation-linked bonds, which, at the current inflation rate, offer lower returns.)
The bonds are not designed for month-to-month savings. However, with a little ingenuity you could structure your savings to take advantage of their attractive rates, especially if you also used a higher-interest savings account, such as Capitec’s savings account. After saving for a year in the Capitec account, you could put the accumulated amount into RSA Retail Bonds for two terms of two years each. After saving for another year at Capitec, you could put that year’s savings into a three-year RSA bond, and after saving for a third year at Capitec, you could put that year’s savings into a two-year bond. For years four and five, you would have to keep your money in the savings account – unless, of course, you wanted to carry on beyond five years (see table, link at the end of this article).
* Nedbank has recently advertised retail bonds with similar conditions to the RSA bonds (also R1 000 minimum, zero costs), and on May 31 they were offering higher rates: 7.37 percent for two years and 8.66 percent for three years for people under 60, and 7.49 percent for two years and 8.81 percent for three years for people over 60. Using the above calculation method and the under-60 rates, your total after saving R500 a month for five years would be R35 584.
8. UNIT TRUSTS
Unit trust funds are an extremely flexible type of investment, allowing you to withdraw money or put in extra when you want to. Your choice is extremely wide – currently there are nearly 800 funds in South Africa available to individual investors, excluding offshore funds marketed here. These cover all asset classes, asset sub-classes (for example, resources shares or financial shares) and various mixtures of asset classes. However, not all funds are available to someone who wants to invest R500 a month; for many, the monthly minimum is higher.
There are various types of funds, according to the assets the fund invests in. We consider here just three common broad types of unit trust: low-risk domestic money market funds, medium-risk domestic prudential funds, and high-risk domestic equity funds.
Only the money market funds offer yields in line with prevailing interest rates, but they are usually better than most bank deposit rates, although yields can fluctuate daily. The others are subject to the fluctuations of the markets and returns can vary widely. You can consider past performance when assessing a fund, but this is no indicator of future performance. To get a good idea of consistency of performance versus the amount of risk taken by fund managers, it’s advisable to look at a fund’s PlexCrown rating (refer to link at the end of this article).
In the unit trust universe, actively managed funds, in which fund managers move in and out of assets to take advantage of market conditions, generally have higher asset management fees and often also charge performance fees.
All funds publish a total expense ratio (TER), which represents the annual management costs, administration costs and various other fees, including bank charges and taxes as a percentage of your investment. The TER can range from less than one percent to more than three percent. It does not include the initial investment fee that unit trust companies often charge, nor does it cover the commission or fee that goes to your financial adviser, if you are using one.
* Money market funds. Those that accept a minimum of R500 a month or less are Allan Gray, Community Growth, Coronation, Metropolitan and RMB. At the end of May 2011, annualised yields ranged from 5.16 to 5.67 percent (net of costs), according to ProfileData. TERs are low, ranging from 0.3 to 0.63 percent.
* Asset allocation prudential funds. These funds distribute their assets across equities, property, bonds and cash, and cannot hold more than 75 percent of their assets in equities. Their performance is not generally as spectacular as equity funds but, because of the diversification of investments, neither are they as volatile. Although their risks vary widely, they are generally lower risk than pure equity funds. Over the past five years, to the end of the first quarter 2011, the top 10 prudential funds achieved an average of 10.72 percent in annualised returns (according to ProfileData), net of costs. TERs are higher than money market funds – those of the top 10 funds range from about 1.2 to 1.88 percent.
* Equity funds. Domestic equity funds invest at least 75 percent of their portfolios in shares on the JSE, and many invest up to 95 percent. In the past they have provided the most attractive returns for long-term investors, but, because of the volatility of share markets, there is a relatively high chance of capital loss over the short term. If you are saving R500 a month, two factors count in your favour:
* You are investing monthly, rather than investing a lump sum, and this tends to smooth out your returns (when the unit price drops, your monthly R500 buys you more units); and
* Your savings are discretionary, so that, in the case of the markets taking a dip just before your five years are up, you could probably afford to keep them in a while longer to “ride out the storm”.
Over the past five years, to the end of the first quarter 2011, the 10 top-performing equity funds (including specialised equity funds, such as resources funds) achieved average annualised returns of 16.56 percent (according to ProfileData). TERs of the top 10 funds range from 1.15 to 2.65 percent.
9. EXCHANGE TRADED FUNDS
Exchange traded funds (ETFs), a relatively new type of investment, are similar to unit trusts in that they invest in the financial markets and are as easy to access. If you go through the online platform etfsa.co.za, which covers all exchange traded products in South Africa, the minimum monthly investment is R300.
Most ETFs passively track an index, such as the FTSE/JSE Top 40, by holding the shares in the index in the same proportions. As such, they perform in line with how the index performs (although there is the drag of costs), which is often better than many actively managed funds. Currently, you don’t have the wide choice that unit trusts offer, especially regarding the underlying asset classes.
ETFs are mostly equities-based, and these have a similar risk profile to equity unit trusts. However, some newer ETFs invest across asset classes – one range, Absa’s NewFunds Multi-Asset Passive Portfolio Solutions (or MAPPS), even complies with regulation 28 of the Pension Funds Act, which governs the asset allocation of retirement-related investments.
Only relatively few ETFs have been around for longer than five years. One of the most established, the Satrix 40, which tracks the FTSE/JSE Top 40 index, has had annualised growth of 12.17 percent over five years to the end of the first quarter of 2011. However, the more specialised Satrix Fini, which tracks the FTSE/JSE Financial index, has returned only 5.44 percent annually, on average, over the same period, in line with the relatively poor performance of financial shares, especially through the global credit crisis.
The best-performing ETF over three years has been the Satrix Divi Plus, which tracks an index of shares that provide good dividends – annualised growth to the end of the first quarter of 2011 was 17.3 percent.
ETFs have become popular because they are less costly than active funds: TERs are mostly under one percent, although, according to etfsa.co.za, some specialised ETFs have TERs of up to 1.68 percent. However, because ETFs are traded like shares on the stock exchange, they incur some additional costs, such as brokers’ fees, which are usually not included in the TER.
10. ENDOWMENT POLICIES
Life assurers offer discretionary investments in the form of endowment policies. These force you to save, because you are bound to a contract for a fixed period. Generally, there are heavy penalties if you break the contract by, for example, stopping payments or withdrawing your money early. The penalty is up to 15 percent for those policies entered into after January 1, 2009, although the penalties typically decrease the longer you save, especially after the first year. Depending on the policy, you may be allowed a no-payment window period, have access to part of your investment (but only once in the first five years), or borrow against your investment if you need the money urgently.
You generally have a choice of investing either in market-linked portfolios, which are subject to the vagaries of the markets and offer no guarantees, or lower-risk, partially or fully guaranteed portfolios and smooth-bonus portfolios.
With a guarantee, your capital at least is guaranteed on maturity, and with a smoothed-bonus investment your annual returns are smoothed (lowered in good years so that they can be raised in bad years), counteracting market volatility.
Endowment policies have tax implications of which you need to be aware. You do not pay tax on your earnings; life assurance companies pay income tax on your behalf on interest and foreign dividends at 30 percent and capital gains annually at an effective rate of 7.5 percent. This is only an advantage if your marginal tax bracket is higher than 30 percent and you expect to exceed your annual tax exemption threshold for investment income. The CGT may also be to your disadvantage because you could lose out on CGT exemptions, and you may pay more than necessary because it is calculated annually.
Endowment policies can also incorporate a risk aspect such as a “premium waiver” option, where, if you suffer a disability and lose your means of income, your premiums are covered for the contract period.
Note that these features usually cost extra, and it is worthwhile to weigh up their benefits against the drain on your returns.
Cost structures are often complex. Costs can include an adviser’s commission, annual platform administration fees (in some cases a fee per premium), and annual asset management and performance fees. With some products, you can invest directly, cutting out the adviser costs.
Because of the complexity, assurers often express total costs as the “reduction in yield” (RIY), which is the number of percentage points costs reduce the annual return on the underlying investment.
The following products, from three big life assurers and three investment houses that have a licence to sell endowment policies, offer a minimum monthly investment of R500 (or less) for a five-year term:
* Liberty Life. Investment Builder gives you access to a wide range of funds that cover all risk profiles. These include Liberty’s internal Excelsior range, selected external managers such as Stanlib, and its property portfolio. The website provides performance data for the funds. Nico-Louis Minnie, the head of investment customer value at Liberty, says there is a flat three-percent annual management fee, no matter what fund you’re in, and you can change funds at no cost. After five years, Liberty will refund you 25 percent of its management fees. If you go through a financial adviser, the adviser can charge you up to 1.5 percent a year for the first five years. An optional performance guarantee on Excelsior funds guarantees your capital for an extra annual cost of 0.4 to 1.5 percent, depending on the risk profile of the fund.
* Old Mutual. The Max Investments endowment range offers a choice of core funds managed by Old Mutual Investment Group South Africa as well as funds of external managers. Max Investments product manager Jaco Gouws suggests the Flexible Plan, which does not tie you into a contract. For tax purposes, you can choose the Life Pure Investment Wrapper (you’re taxed at 30 percent by Old Mutual) or the Linked Investment Service Provider Wrapper (you’re taxed at your individual rate when you sell your investment, and may even be tax-exempt).
Gouws says the RIY over five years is 4.79 percent, but this would reduce to 3.71 percent over 10 years. For Old Mutual’s Smoothed Performance Fund, the bonuses (returns) over the five years to the end of 2010 varied between five percent (2008) and 25 percent (2006), these figures being net of investment charges and tax.
* Sanlam. The Stratus Endowment offers a selection of Sanlam and external funds, and Sanlam publishes daily reports of fund performance. Some of the lower-risk funds have a guarantee option. Or you could invest in the Vesting Bonus Fund, in which returns are smoothed (the RIY in this case would be 4.8 percent). Bonuses on the fund over the five years to the end of 2010 varied between 3.1 percent (2009) and 20.4 percent (2006). After five years you receive a loyalty bonus calculated as a percentage of accumulated costs.
* Allan Gray. Under this endowment policy, you can choose from a wide selection of Allan Gray and external unit trust funds. Apart from the fund management fee, which varies from fund to fund, Allan Gray charges a maximum annual administration fee of 0.5 percent of assets, which is reduced to the extent that it receives any discount from a fund. There is no net administration fee for Allan Gray funds. Returns are taxed at 30 percent in the hands of Allan Gray.
* Coronation. Coronation offers an endowment plan with growth taxed at 30 percent. You may select from a focused range of Coronation unit trust funds, and switching between them incurs no costs. You pay only the annual fund management fee, which varies from fund to fund; the platform administration fee is “fully subsidised” by the company.
* Oasis. Oasis’s new endowment policies invest in a high-equity portfolio (with a benchmark of CPI plus three or four percent) or a progressive portfolio (CPI plus one or two percent). Fees, apart from an adviser’s fee (up to three percent), are an annual 0.4-percent administration fee and a fund management fee of one to three percent based on performance. Returns are taxed at 30 percent in the hands of Oasis.
WHAT THREE TOP FINANCIAL ADVISERS RECOMMEND
A senior investment broker at a major investment bank is known to have scoffed at someone asking for advice on how to invest R500 a month, suggesting he spend the money instead.
The response was almost certainly tongue-in-cheek, but what message does it send to someone who may not be a big earner but who has the desire to save?
Natasja Norval Hart of Sasfin Financial Advisory Services in Pretoria has a Certified Financial Planner (CFP) accreditation and last year won the Financial Planner of the Year award. Norval Hart says that saving even a relatively small amount is at least a start.
“Remember, it is the cents that make the rands. So by reviewing your budget and rather saving R500 a month than letting it disappear into your monthly living costs, you are creating a habit of saving. We live in a society of instant gratification, and one of the biggest challenges is to show the benefits of saving and giving up on some luxuries now to have more options later. By starting to save, putting R500 a month away, you can ensure that you are changing your financial destiny,” Norval Hart says.
Alec Riddle of Consolidated Financial Planning in Port Elizabeth, a CFP who won the Financial Planner of the Year for 2009, says it’s important to take that first step.
“Just setting a goal to save or invest and accomplishing that is in itself an achievement. Achievement is, of course, the first step to self-improvement, and success breeds success,” he says. “It is also important that you understand the various asset classes and the benefits of diversification and time, plus the magic of compound interest.”
Riddle says although paying off debt should be a priority, sometimes, if clients have the means, he might suggest alternatives.
“I would suggest extra funds be directed to the bond, but at least a portion thereof be directed to a smaller discretionary investment, so that they learn about investments with a small amount. This way, they are more likely to invest appropriately when their bond is paid up, or when their provident fund becomes available,” Riddle says.
The advisers generally feel that you need to keep an eye on your overall financial plan, even with a relatively low discretionary amount of R500 a month, not least because you could be saving on tax if you put the money into a retirement annuity or, under certain conditions, into an endowment policy.
Norval Hart says: “People in the top tax bracket often use endowment policies to minimise their tax, because with an endowment you don’t declare any income or gains to the South African Revenue Service (SARS); the life company does that and pays 30 percent tax on your behalf.
“However, if your interest exemption has not been fully utilised, it may make sense to rather use a unit trust vehicle. With a unit trust, your income and capital gains are taxed in your own hands. This means that you have to declare any share dividends and interest that you earned in the unit trust during the tax year. The unit trust company sends you a certificate with the figures that you will need to complete your SARS tax return.”
One of the biggest advantages of unit trusts is their flexibility. Norval Hart says: “Liquidity is one of the major factors to consider when investing (the other two being tax and costs). With an endowment, there is a minimum investment of five years. With a unit trust, you have access to the market value of your portfolio within a few days.”
Riddle adds: “Your investment needs to be flexible, enabling you to change the amount invested or even cash in your investment, without excessive penalties, should your circumstances change. Far too many investors in the older type endowments and retirement annuities have been ‘burnt’ with excessive penalties if they have needed to change their investments.”
Riddle says he would advocate a unit trust with exposure to a variety of asset classes (for example, a prudential asset allocation or “balanced” fund), as long as it is cost-effective. “The reasons for this recommendation would be to ensure inflation-beating returns while helping you better understand the investment market.
“However, if you are a DIY investor and purely looking at a five- to 10-year time horizon, with no guidance from a financial planner, then I would encourage you to look into the possibility of investing in one of the exchange traded funds, such as a Satrix fund. A word of caution, though, if the fund is 100-percent equity-based: the markets can be very volatile.”
Ian Beere, a CFP at Netto Financial Services in Cape Town, who won the Financial Planner of the Year award in 2007, recommends a diversified investment. He suggests you invest in a portfolio that includes more than one asset class (the major asset classes are shares, property, bonds, cash and offshore assets).
Beere says: “Shares are the key driver of higher long-term returns but can also be the most risky. Thus an investment with a greater exposure to shares will have the greatest return over time, but will experience more ups and downs than an investment with a small exposure to shares.
“Cautious investors will likely elect to invest in cash with no chance of losing money but would have to accept a lower return over time, meaning they may not achieve their goal. Care-free investors will likely invest in an investment comprising mostly shares. While this would yield the best return in the long run, they may lose money if they draw it out at the wrong time.
“Therefore, we advise against investing money based on personality but based on what you need to achieve over the time you have, taking your circumstances into account. The above two investors would therefore not necessarily end up investing in different investments if we were advising them,” Beere says.
Norval Hart says you must always be mindful of costs, but by investing in a moderate-risk balanced fund, you avoid “putting all your eggs in one basket”.
She says: “Balanced funds tend to have a diversified blend of asset classes. Since one is only invested for a five-year term, this is more reason to avoid investments with high equity – if the market does take a dip, the fund might not have sufficient time to recover.”
And what investments should you avoid?
“First and foremost,” Beere says, “avoid any investment that is not regulated by the Financial Services Board. Countless investors have lost money to unregulated schemes after being attracted by the ‘too good to be true’ returns.
“Another product to avoid is one where there is no flexibility for a change in circumstances. An investment policy with a long contract term that imposes hefty penalties for withdrawing early would be a good example. You also want to avoid using the right product in the wrong place. For example, a retirement annuity is not a good way to save for a new car.
“Finally, remember that the investment strategy decision is separate from the product decision.”
Looking at how your R500 a month fits into the bigger scheme of things, Beere says it’s best to talk to an independent adviser.
“Engage with a professional and get advice and a financial plan in place,” he recommends.
This article was first published in the third-quarter 2011 edition of Personal Finance magazine putting yearly savings into retail bonds.