Errol Meyer, Head of Advisory Services at Standard Bank Financial Consultants, says most people start their financial planning by looking for a product that will give them the best expected returns over a particular time. But, he says, it’s better to start with your end-goal in mind and then match that with the best products.
If your goal is short-term, like saving for a child’s education, a tax-free investment vehicle could be your best option. You can invest R33 000 a year, and ‘cash out’ at the end of your investment period without incurring any exit tax. The growth build up is also tax free, complementing the compound-growth principle.
The trick here is not simply to invest in the product that offers the best anticipated return to maximise your potential capital amount; you should define how much you need over the investment term, then choose a suitable return profile to get you there.
“If an inflation-plus-3% strategy will get you to your investment goal without exposing you to undue risk, there’s no point in putting your money in a more aggressive product,” says Mr Meyer. This is pertinent when your goal is short-term in nature, as short-term market fluctuations could wipe out your returns.
If an inflation-plus-3% strategy is not aggressive enough to get to your final goal, but is important to not miss that goal at the end of the term, contribute a slightly larger amount to a product with a more moderate returns profile, rather than targeting a more aggressive solution. For example, if you’ve calculated that you need to invest R15 000 a year in an inflation-plus-3% product for your child’s education but your expected return after the four-year term isn’t what you require, put away R16 000 a year into the same product rather than exposing your R15 000 to a more aggressive one.
If your investment goal is long-term, like wanting to retire at 65, you can afford to be relatively more aggressive, because you have time to recover from short-term market volatility, assuming you’re not nearing retirement age. For example, if you earn an annual salary of R600 000 and you want to maximise your retirement savings potential, take the full 27.5% tax-break allocation that you can place in an RA. This will leave you with R435 000 from which you’ll pay R90 408 in tax (after rebates), leaving you with a final sum of R344 592. From this, allocate a portion to a tax-free investment with an aggressive strategy, allowing for a relatively high equity weighting.
“The nice thing about this option is that the amount you apportion to the tax-free vehicle is exempt from Regulation 28, as the contributions are coming from after-tax income,” says Mr Meyer. “This allows you to adopt a far more aggressive strategy than you would in your RA and benefit from the tax-savings as well.”