Errol Meyer, Head of Advisory Services at Standard Bank Financial Consultants.
Developing a solid financial plan should begin with defining your goals and then matching those with the appropriate investment solution that will maximise your chance of achieving your investment target, rather than honing in solely on expected returns.
“Most people start their financial planning by looking for a product that will give them the best expected returns over a particular timeframe,” says Mr Errol Meyer, Head of Advisory Services at Standard Bank Financial Consultants. “However, it’s far better to start with your end-goal in mind and then match that with the best product solution to help you reach your goals within the specific parameters or constraints that you are working with.”
Current estimates indicate that only between 3% and 6% of South Africans can afford to retire, thanks to the country’s low savings rate. That’s at least partly due to South Africa’s exceedingly high household debt to disposable income ratio which reached 71.9% in 2017 according to the latest Reserve Bank quarterly bulletin, which also showed that the nation’s gross saving as a percentage of GDP fell to 15.8% in the fourth quarter.
Mr Meyer says that before embarking on any financial planning exercise, you should first try to improve your cash flow by paying off any short-term, high interest debt you have incurred, particularly for consumption expenditure. Once that is done, you need to define the term of the investment goal (i.e. is it a short term goal like saving for your children’s education, or is it a long-term goal like saving for your retirement?). With either option you need to remember that compound interest is your friend, while inflation is your enemy.
If your goal is short-term like savings for a child’s education then a tax-free investment vehicle or even a unit trust could be your best option, says Mr Meyer. The advantage of this option is that it allows you put up to R33,000 a year in a tax free investment vehicle, which means you can cash out at the end of your particular time horizon without incurring any exit tax. An additional advantage is that the growth build up in the fund is also tax free with the result being that it complements the compound growth principle.
The trick here says Mr Meyer, is not to simply invest in the product that offers the best anticipated return in order to maximise your potential capital amount. What you should do is define how much you require over the investment term and then pick a suitable return profile to get you there.
“If an `inflation-plus-three-percent’ strategy will get you to your investment goal without exposing you to any undue risk then there’s no point in putting your money in a far more aggressive investment product that could expose you to more risk,” says Mr Meyer. “This is particularly important when your goal is more short-term in nature as any short term market fluctuations could wipe out your returns and prevent you from reaching your ultimate goal. The real risk is that you may not have the funds when needed at that particular time for that particular goal.”
If an `inflation-plus-three-percent’ strategy is not quite aggressive enough to get you to your final goal, but it is important for you not to miss that goal at the end of the term, Mr Meyer recommends rather contributing a slightly larger amount to a product with a more moderate returns profile than targeting a more aggressive solution.
“If you have calculated that you need to invest say R15 000 a year in an inflation plus three percent product for your child’s future education and your expected return after the four year term isn’t quite what you require then rather consider putting away for example, R16 000 a year into the same product rather than exposing your R15 000 to a more aggressive product targeting say, inflation plus five percent,” says Mr Meyer.
Alternatively, if your investment goal is long-term like wanting to retire at age 65, or provide for medical expenses after retirement, then you can afford to be relatively more aggressive as you have enough time to recover from short-term market volatility, assuming you are not nearing retirement age of course. For example, Mr Meyer says that if you earn an annual salary of R600 000 and you want to maximise your long-term retirement savings potential then you should take up the full 27.5% tax break allocation that you are able to place in a retirement annuity (RA).
This will leave you with R435 000 from which you will have to pay R90 408 in tax (after rebates) leaving you with a final sum of R344 592 from which you can then allocate a portion to a tax-free investment with an aggressive strategy, which typically allows 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, which is constrained by Regulation 28, and benefit from the tax-savings as well.”
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