Investing a lump sum - Considerations for investors

Hugo Malherbe, Executive of Product Development at PPS Investments.

What is the best way to invest a lump sum to maximise tax-efficiency and growth potential for an investor? There are a number of options and considerations, which should be thought through carefully to ensure that the investments selected are well-matched to the circumstances and needs of the investor. When decisions of this nature need to be made, independent and objective advice is invaluable.

It is important to take stock of the investor’s current financial position, their aspirations, their plans for the money and the factors that influence their decisions. Does the money need to fund day-to-day expenditure? Or is there a particular future event to provide for? One investor may need to be liquid to a greater extent than another. Someone on the verge of retirement may benefit from an annuity more so than a young professional entering the workplace with a wedding on the horizon. Keeping these unique circumstances in mind is the most effective way to increase chances of positive outcomes for investors. In addition, the rule of thumb when selecting underlying unit trusts is to diversify as much as possible and to take an appropriate level of risk which suits the investor’s needs.

Many investment platforms offer both unit trusts and direct shares for investors across a range of suitable products. We always recommend investors seek financial advice to determine what product and unit trust is suitable for them. Here we explore some simple options for investing a lump sum.

Investing for retirement

When saving for retirement it is important that one’s retirement portfolio is managed according to Regulation 28 of the Pension Funds Act, which prescribes asset class limits. When selecting unit trusts, it is possible to maximise the investment potential by targeting growth that outperforms inflation. For some investors, a diversified multi-asset portfolio with a higher equity exposure may be worth considering over the long term, with the guidance of a qualified financial planner.

A retirement annuity is typically a good long-term investment vehicle within which to select these unit trusts. A retirement annuity provides a tax deduction to the investor on contributions and allows for tax-free growth during the investment term. It encourages disciplined investing over the long term as it does not permit withdrawals of funds before retirement, except in the case of emigration. At retirement, if the total fund value exceeds R247 500, investors are limited to receiving one-third of their retirement benefit as a cash lump sum on which there is no tax for the first R500 000. The remaining two-thirds must be used to receive a monthly annuity income. The income is treated as part of the investor’s monthly taxable income.

A tax free investment account can also be a tax-efficient way to supplement retirement savings and allows investors to invest in underlying unit trusts. With a tax free investment account investors can contribute a maximum of R30 000 per annum and R500 000 over their lifetime. There is no tax paid on interest earned, capital gains, dividends or investment growth. Proceeds are completely tax free in the hands of the investor. With these investments however, withdrawals cannot be replenished so the investor’s tax advantage will be maximised the longer the investor remains invested.

With both a retirement annuity and a tax free savings vehicle, investments can better maximise growth of an untaxed amount over time.

Investing for a long-term goal (around seven to ten years)

When saving for a specific goal and when the time horizon is between seven and ten years the investor should aim to maximise investment growth by taking a higher level of risk while also considering the tax implications of an investment over a longer term.

Over this period, unit trusts suited to a longer-term investment horizon such as those focused on growth could stand investors in good stead. Investors might be more comfortable with short-term volatility due to the long-term view and could opt for asset class specific funds like local equity or fully focused offshore funds. However, as the investor nears the intended date they would like to use the funds accumulated within the investment, it may be worth considering whether there is a need to de-risk.

For some investors an endowment can offer a tax-efficient structure within which to select these unit trusts. In particular, an endowment is an investment option designed to offer tax benefits to income earners with marginal tax rates greater than the flat 30%, levied in the hands of the insurer who owns the underlying investments within the endowment. Even though the investment is fixed for the first five-years, investors still have restricted access to one capped withdrawal. At the end of the period the investor has unrestricted access to the savings. However, the investment may continue open-ended and tax free withdrawals may be taken when required. Due to tax savings, this investment option could boost investors’ final returns.

Investing for a short-term goal (Up to five years)

A shorter-investment term typically requires more flexibility and greater appreciation for volatility in the market. If the investor has a specific goal and the lump sum remains invested for only five years, an investment option with lower volatility should be considered over the need for high-volatility growth assets.

A multi asset investment offering over a shorter time horizons would generally be considered with a medium-to-low focus on equity, such as a moderate or conservative unit trust. For shorter time horizons such as one or two years, a greater focus on capital preservation than growth would generally be required, such as that offered within fixed-interest focused unit trust.

An investment account is a flexible solution with no withdrawal restrictions that also typically allows investors to construct their personalised portfolio by investing directly in a selection of unit trusts. The offering provides no tax benefits (apart from the various tax exemptions and exclusions available to all tax payers each year) and all growth, dividends and interest is taxed in the hands of the investor.

An Investment Account has tax implications if the investor chooses to switch between unit trusts. When investing in a fund of funds or multi-managed solution, however, changes can be made to underlying funds by the multi-manager without incurring tax events.

A multi-managed unit trust makes use of a complementary mix of single asset managers, each of which behaves differently. By combining various asset managers, an investor stands to benefit from diversification not only across asset classes but also across different investment processes and views.

Such a strategy allows, for example, a growth-focused asset manager to be complemented by an asset manager that is defensively positioned to offer better protection when markets fall. It also removes the reliance on any single asset manager to achieve an investor’s objectives on its own. A multi-managed unit trust also has the potential to offer more consistent performance. In contrast, a single manager fund will offer a more focused investment view that may outperform the more diversified multi-manager solution. Investors that are more tolerant of the potential short-term volatility of such a strategy might prefer this sort of option.

Finally, an investor must consider the cost they are paying to invest. With clean fees, costs are becoming easier for investors to understand, and while it may not need to be the primary deciding factor, it should be something to be well aware of. What is the size of the lump sum and what is the fee charged for administration, advice and asset management?

Ultimately, an investor, along with their financial planner, is best placed to navigate the various investment options available. Whatever the option, it needs to be tailored to an investor’s unique requirements, and be part of a holistic financial plan guided by an accredited, reputable financial planner. It also needs to be regularly reviewed to ensure the investor remains on track.