Investing for the first time needn’t be scary or overwhelming, writes Wessel Brand, Portfolio Manager at Sygnia Asset Management, as long as you know the secrets to starting out right.
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You’ve made it beyond the ‘Salticrax for the last week of every month’ stage of your income-earning life. You’re a bit older but still young(ish), and finally have a bit of extra cash at the end of each month. You know the smart thing to do is to invest, and you want to, but you don’t know where or how to start.
If this roughly describes your current financial situation, take comfort in the fact that you’re not alone. A recent study conducted by data analytics firm Kantar found that most South Africans do realise the importance of saving and investing but are put off by the complexity of formal savings and investment options.
Now for the good news: you don’t need to have a lot of money or know anything about investment to make your money work really well for you. That’s because there’s an easy, simple and safe investment option that you can access with little capital and zero financial knowledge. And here’s what many in the financial world don’t want you to know: this option will deliver between 22% and 42% more growth than more complex, time-consuming investment strategies.
Say hello to the tax-free savings account (TFSA), brought to you courtesy of the South African government.
Introduced in March 2015 as a means to encourage South Africans to save, the TFSA is a 100% tax-free investment vehicle available to every citizen, from newborns to retirees. It allows every citizen to invest R36,000 per year, up to a maximum lifetime contribution of R500,000.
You may have heard about TFSAs, but judging by the mediocre uptake of this golden opportunity I suspect most South Africans don’t fully understand the incredible benefits of choosing it as a first-time investment vehicle.
And so I present to you three solid reasons why a TFSA should be the first vehicle for any investor, regardless of how much or little you have to invest.
1 | A Little Makes A Lot
The beauty of paying zero tax is that it allows your investment to achieve its fullest potential over time due to the positive effect of compounding interest year after year (there’s a reason Albert Einstein described compound interest as the “eighth wonder of the world,” adding, “he who understands it, earns it; he who doesn’t, pays for it.”)
So, while R36,000 a year may not seem like a huge amount, throw the full effect of compounding interest into the mix and it can amount to a tidy sum over the years.
2 | Zero Expertise Is A Bonus
Hollywood movies may have you believe that if you time the market and/or pick that one winning stock you’ll hit the big time. Sure, there are those lucky few who bought into Apple in the very early days and are now living it large, but they are few and far between. For the rest of us, the fact is that slow and steady always wins the race – and I have the numbers to prove it!
I wanted to see how a tax-free investment strategy performed in comparison to two other common non tax-free investment strategies. So I applied the same amount of money (the maximum tax-free allocation of R36,000 per year up to R500,00 per lifetime) over the same period (30 years) to the same baseline assumptions* for these three investment strategies.
Investor A is a long-term investor who invests his full annual allocation of R36,000 in a fund-based TFSA, hitting his lifetime contribution limit of R500,000 in year 14.
Investor B is also a long-term investor, but she switches underlying investments once every five years to take advantage of market opportunities.
Investor C is an active short-term investor who aims to time the market and pick big winners, and therefore switches the allocation of his underlying investments at least once a year.
My calculations show that Investor A ends with an investment growth of 22.5% more than Investor B and 41.9% more than Investor C over a 30 year period.
Why Investor A performs better than Investors B and C is explained more below (see ‘Crunching the Numbers’), but the long and short of it is: you need zero expertise or admin effort to make your starter investment work brilliantly over time. All you need to do is: open a good fund-based TFSA with low fees (aim for maximum fees of 0.2% and 0.4%, or slightly higher for more exotic passive funds); pay your monthly instalment or make an annual lump sum investment (equaling no more than R36,000 per year) before the 28 February each year; then forget about it. In 20-30 years, you get to pat your younger self on the back as you cash in.
3 | Control What You Invest In
There’s a common misconception that TFSA’s are a single or set investment product, like the fixed interest money markets accounts offered by most major banks (which I strongly advise against, as you’ll risk the opportunity to maximise your tax-free allocation – but more on this in part 2 of this article).
The fact is that a TFSA is purely an investment vehicle that is regulated by the South African government. Provided it sticks to certain regulations (i.e. it has to have low fees), a TFSA can take many shapes and forms. The underlying investment can be an Exchange Traded Fund (ETF), South African Unit Trusts and, yes, even those money market accounts.
With more than 70 ETFs listed on the Johannesburg Stock Exchange and 1,600-plus unit trusts on offer, you get to decide whether you want to invest 100% offshore, 100% in domestic (SA), or a mix between the two.
Which leads me to the second misconception about TFSAs: it doesn’t have to be a single investment vehicle. You have an annual tax-free allowance of R36,000 and there are no restrictions on how you split that amount.
So you could, for example, choose to split your full allocation over two or three offshore ETFS based on factors ranging from your appetite for risk to your moral compass and niche interests, such as ETFs that invest in clean energy technology, cutting edge health innovations or even cannabis. Or you could make it super simple and invest in a single TFSA linked to an index fund that has a wide exposure to the broader market, such as the Sygnia Itrix MSCI World Index ETF or a balanced fund like Sygnia Skeleton Balanced 70 Unit Trust. The choice is, quite literally, yours.
I hope this introduction to the benefits of tax-free investing has got you motivated to start your investment journey with a TFSA – your older self will definitely thank you for it.
In part two, 5 Guidelines to Select the Right Tax-Free Savings Account, I go into more detail on what sort of TFSA you should and shouldn’t consider, along with some important do’s and don’ts for first-time investors.
Crunching The Numbers
Ends with an investment growth of 22.5% more than Investor B, and 41.9% more than Investor C over a 30-year period.
This is because Investor A never pays taxes on profits realised when switching between underlying investments in their TFSA, and never loses out to Dividend Withholding Tax, which is 20% on all dividends received from underlying investments.
Delivers 22% less growth than Investor A, because Investor B has to pay Capital Gains Taxes on their realised gains. Plus Investor B is also liable for Dividend Withholding Tax (20% on all dividends received).
Delivers 41.9% less growth than Investor A, because Investor C is liable to include all realised gains annually with their personal income tax. For this calculation I used the South African Revenue Service’s (SARS) lowest taxation bracket for a natural person (18%), and included the primary tax rebate for natural persons (R15,714 for 2022 financial year). If your tax bracket is higher, the taxable portion will increase accordingly, resulting in even lower returns on investment.
* Baseline assumptions used:
- Annual Contribution of R36,000
- Maximum lifetime contribution: R500,000
- Capital Growth: 10%
- Dividend Yield: 3%
- Dividends are reinvested at every year-end
- Time Span: 30 Years
- Personal Income Tax Rate: 18% (lowest of the tax charged brackets)
- Capital Gains Tax (40% inclusion rate, and 18% personal income tax rate)
Also read What is a Tax Free Savings Account?