Achieving financial harmony | Notes for investing success

Achieving financial harmony is not easy - but it is simple. This sounds paradoxical, but it makes sense once you know the steps to take and the habits to implement. Then, it’s a matter of staying the course. What can feel confusing is what to do first, and in what order. Hence the notion of harmony: investing is a bit like a jazz song, and harmony comes from having different notes playing at the same time.

The base note of financial harmony is having funds saved for emergencies or opportunities. Life happens: your car breaks down, your laptop crashes, your dog or child gets sick. Or you get a chance to invest in a new business or in your own self-development. It’s important to have savings for these life events, both unforeseen and opportunistic, but it requires discipline to achieve.

These funds need to be liquid (available in 48 hours) and invested in cash or near cash. A rule of thumb is to have three to six months of living expenses set aside. The more uncertain the future feels, the greater the buffer required.

Retirement savings

Once this base note is in place, or while you’re saving for emergencies, you can add the retirement savings ‘high notes’ to take care of your future self. These investments require time to grow and compound and you should set them up as soon as possible.

As retirement savings are a long-term goal, you would typically be able to afford to take on more market risk. The risk with this note is not whether the markets move up and down (which they will), but whether you can meet your retirement goals. Financial planners often suggest a replacement ratio of 75% of your current salary as a rule of thumb (assuming you won't have ongoing mortgage payments or retirement savings contributions in retirement).

To establish a target for this ratio, a rough estimate is to multiply your monthly salary by 200. While this figure may seem daunting, it's crucial to recognise that time plays a critical role in investing: the real benefits of compounding emerge in the long run.

The Rule of 72 (the double-your-money rule) helps to illustrate why taking on more risk is important if you have time on your side. The Rule of 72 is a simple way of working out how long it takes to double your investment for a level of return.

Let’s say you saved R1 million from the age of 30 to 40. Assuming you had invested those funds at an 8% return per year over the long term (a reasonable assumption for a rand balanced fund), the Rule of 72 (72/8 = 9) shows that it would have taken nine years to double your investment.

If you had left these funds in cash at, say 5% return, it would have taken 14.4 years to double. This is why it is so important to start saving early for retirement, or to consider retiring later if you got a late start. Time is required for effective compounding.

The Rule of 72: How many times could you double your investment in 40 years?

Shorter term investments – more stable returns (base note): Example - Investec BCI Active Income Fund of Funds

Medium term investments – diversified with a higher potential for returns (high notes): Example - Investec BCI Balanced Fund of Funds, or offshore Investec World Axis Core Fund

Longer term investments – higher volatility but best chance for higher returns (higher notes): Example - Investec BCI High Equity Fund, Investec BCI Equity Fund or offshore Investec World Axis Equity Fund

The retirement industry is governed by Regulation 28, which ensures that retirement savings are diversified to protect investors. With this protection in place, it makes sense to maximise the Rule of 72 as best you can with your retirement savings.

Taking on market risk over the longer term means this investment note does not play in a straight line like the base note, but rather changes in pitch over time. Choose a reputable asset manager and allow them to play the high notes, accepting the unexpected rhythms of market volatility and reminding yourself that this is a unique variation in the melody, and that you have the base note covered with your cash and near cash savings.

Retirement annuities

A retirement annuity can be used on its own or in addition to your preservation and pension funds. There are also good tax incentives in place to encourage retirement savings. For example, if you added R100,000 of earnings or a bonus to your retirement annuity, you would get back R40,000 in tax (assuming a 40% marginal income tax rate), subject to a maximum of R350,000 a year.

You can also maximise tax-free investments for retirement purposes. Up to R36,000 can be invested in tax-free savings accounts each year. These savings are limited to R500,000 in total and are flexible if the funds are required. Since you can take on 100% equity risk here with tax benefits, they are useful to use as another vehicle for retirement savings.

Once the base and high notes are in place, you can add some improvisation for your unique life and legacy, such as offshore investments for diversification or for future travel or children’s education offshore. You can also try structured products for a different risk/return profile, or pure equity unit trusts for your legacy .

*Please note: this article does not constitute financial advice. Please contact your Investec financial advisor should you require more information on any of these solutions.