3 Good options to invest your year-end bonus
When it comes to your year-end bonus, you probably feel less inhibited in how you spend this money than with your monthly income. This will be especially true if the pay-out coincides with the arrival of the festive season and its many spending temptations.
According to Steven Nathan, CEO 10X Investments, while many may get carried away by the heady effects of the holidays, in the context of our current economic times, investors should see bonuses/13th cheques as extra capital rather than additional income.
Top up your retirement annuity
“To help South African’s make provision for their old age, the Government provides tax incentives on certain investment vehicles, such as pension and provident funds, to encourage people to save for their retirement,” says Nathan.
Topping up your retirement annuity is another great way to avoid paying unnecessary tax. “Over and above the monthly contribution to your company retirement fund, you also have the opportunity to put away an additional 15% of the total value of any non-pensionable year-end bonus, completely tax free.”
Apart from taking advantage of the compound interest on their topped up retirement savings over time, investors will be happy to know that they do not pay income or capital gains tax on the return earned by their retirement funds. “Investors only pay tax when they access their retirement savings. While any annuity payments are taxed per the income tax table, lump sum benefits are taxed on a sliding scale, with the first R500 000 paid out tax free,” says Nathan.
Reduce debt
Besides topping up your retirement annuity, you should also strongly consider using some of the bonus to pay off any high cost debt, such as personal loans and credit cards.
“If you’re paying 19% interest on a R5 000 loan, there is very little sense in putting a R5 000 bonus in a bank account earning interest of 4.5%. By paying off your debt you are effectively ‘earning’ tax free income that you would have otherwise paid your creditor in interest,” explains Nathan.
Homeowners could also consider applying some of the bonus to their home loan to reduce future bond repayments and mitigate possible increases in the interest rate.
But this may not be the best option for everyone. “If you’re paying a low interest rate on a long-term asset appreciating in value, it might make more sense to invest your year-end bonus in the share market rather than accelerating your bond payoff,” suggests Nathan.
Explore other investment options
When assessing potential investment products available the market, people should always bear in mind that to increase the profitability of their investment, the cost of managing the investment vehicle must be as low as possible.
“To maximise your return, investors must consider the total expense of the investment. Ongoing investment management, administration, broker and trading fees are deducted off the investment, dramatically affecting the return” says Nathan.
Nathan warns that investors should be paying a Total Expense Ratio (TER) - worked out as a ratio of total expenses over assets, - of no more than 1.0% pa and nothing more.
“To give an idea of the impact of Total Expense Ratio, a unit trust with a TER of 2% has to outperform one with a TER of 1% by more than 18% over 20 years just to deliver the same return” says Nathan.
Nathan urges investors to establish total annual fees before purchasing a retirement annuity, unit trust or similar investment vehicle, and to insist that financial advisors disclose the full cost of the investment.
When shopping for a unit trust investment, investors may be tempted to compare funds by performance alone. Nathan warns that unit trust returns are always reported after deducting management costs. “Returns fluctuate, but fees are constant. By showing returns net of fees, investors are encouraged to disregard fees, and may thus be tempted to buy a high cost product simply because it has performed well in the past. However, the only guarantee investors have about the future return is the fees that will reduce it. ”
Of course, some of the year-end bonus should be ear-marked for spending, especially as the festive season is filled with additional expenses. “This is the time to buy presents, go on holiday, or pay off school fees; while it is paramount that you take care of your financial future, it’s also important that you and your family enjoy the rewards of your hard work” says Nathan.
“Whether you choose to top up your retirement annuity, pay off your debt or invest in a unit trust, your year-end bonus presents an ideal opportunity to improve your long-term financial health,” concludes Nathan. “Expenses do increase over the festive season, but I would urge employees to resist the temptation to spend their bonus frivolously. Rather look ahead and see this windfall as an opportunity to sustain a higher standard of living in the future.”
