In our August edition of Investment 360, we highlighted the significance of having an investment shield in place. Once this is established, you can start to invest in other long-term aspirations. For example, saving for your or your children’s education, an inspirational sabbatical or even your financial freedom.
The government wants to encourage you to save and be able to take care of yourself and not be a burden to the state. One of the ways it encourages this behaviour is by creating savings incentives, in the form of tax breaks. This incentive is in place with your long-term retirement savings but is also available with a tax-free savings account. Generally, you have to give up some liquidity (liquid means you can draw from it within 24/48 hours if you need it) to gain this incentive, like with your pension or retirement savings, however with the tax-free savings account, you don’t. You can save R36,000 a year tax-free, with liquidity. This feels like a “free” lunch since, unlike a regular savings account, the investment is not subject to tax on any interest, dividends or capital gains – while still being liquid. You can invest up to a maximum of R500,000 per individual in a lifetime.
This means these savings have the benefit of having the returns compounded over time without being eroded by tax. Compounding is what happens when you earn a return on your returns as well as the original investment and not just on the original investment. It’s a way to amplify your money.
The important part about compounding is it requires time. Time is the secret ingredient of compounding. It shouldn’t be withdrawn or spent. This is why using the tax-free savings “garage” might be best optimized for longer-term goals.
A note here on long-term goals. If tax-free savings are taken out in a child’s name for example and then used to save for the child’s education. It is worth noting that the child then loses the ability to use the R500,000 lifetime allowance for themselves (under current legislation). Once withdrawn, the withdrawn portion cannot be replaced. An interesting thought is one could even consider using the amplification of compounding to use a tax-free savings account to provide a cushion for a child’s retirement!
Maximise this tax-free benefit by investing in both husband and wife’s names for example within a family first, before using other savings accounts.
Once you have decided to park your savings in the tax-free savings garage. The next decision is which fund to park in the tax-free savings garage.
The choice of fund depends on the goal of your savings.
Short-term goals should use low-risk funds. Low risk means it should not move up and down often. As mentioned, it is worth considering whether it makes sense to use up your allowance for short-term goals as you might better utilise the tax-free savings compounding benefit for longer-term goals.
However, if you do have a short-term goal or you might need to use the funds on short notice – less than three years you should not take on risk. Risk and rewards are linked.
The Investec BCI Active Income Fund of Funds invests your savings in many different cash or income investments, which is different from having all your shield savings in your bank account. It is also diversified by the fund manager as we partner with the finest cash or income managers for you to find opportunities to maximise your low-risk savings. It is a good investment parking place, for investors looking to outperform cash but that still require liquidity.
If your goal is medium-term, greater than three years away then you can afford to take on more risk. The Investec BCI Balanced Fund of Funds invests your savings in many different cash or bonds, property, and equity investments. It is also diversified by the fund manager as we partner with the finest managers for you to find opportunities and maximise your medium-risk savings.
If your goal is longer, greater than five years then you cannot afford not to take risks and increase your chances of maximising your returns. The real risk for long-term goals is not short-term up and down moves but rather the risk of not achieving a long-term goal because you haven’t taken enough risk (or saved enough).
A long-term investment can be 100% invested in equity. This means it will be volatile (move up and down) as risk and reward are correlated. It can take time to get used to volatility, it is important to be mindful of that from a behavioural perspective. It can feel stressful when the market or investment moves down, but it is really important to learn to train your nervous system to handle this. The important thing to note is markets move up and down and that is why you need time. You need to be able to ride through the cycles. You are choosing an investment management company with experience and resources and they are making informed decisions about your capital for you. Your part is to invest and hold.
A good local investment choice for a long-term goal, like saving for retirement would be the Investec BCI Balanced High Equity Fund. This is a multi-managed fund that has exposure to various asset classes but a bias towards equity exposure. The Fund is actively managed using a top-down view of economies and markets to assess the relative attractiveness of equities, bonds, property and cash, and to determine an optimum exposure to offshore markets.
Another option for long-term investing is to broaden your investment horizons and access the international markets via a feeder fund (a South African rand-denominated fund that invests offshore on your behalf). It is important to note the currency risk (the Rand moving up and down) will be added to market risk. Again, it is just important to train your nervous system. If your goal is long-term, then you can afford to take on the risk and move through the cycles. This means you can access offshore companies via a tax-free savings account. It is important to note the capital will always need to be brought back to South Africa when you sell the units. A good option here would be the Investec BCI World Axis Global Equity Feeder Fund. Which invests your savings in offshore companies/ equity investments. It is also diversified by the fund manager as we partner with the finest global managers for you to find opportunities to maximise your high-risk savings.
So once you know you want to access your “free lunch” via a tax-free savings account. Get clear on your investment goal and then get saving and get your money working for you.