Financial Investing in a Nutshell
The basics of financial investing
I believe in having a long-term perspective when investing, rather than worrying about short-term fluctuations. With a diversified and balanced portfolio, you will always win in the long run, by following the general market growth trend. What you should focus on is in which proportions you should divide your investment money amongst the four asset classes (money market, government bonds, property funds, and equity / stocks), according to what your goals are, and also to keep an eye on fund management fees. Another element of diversification is exposing your money to the global market. I will now explain these points in more detail.
The asset classes mentioned are presented in order of stability. The more volatile an investment is, the higher amount of growth it has in the long-run. So, there is a trade-off between stability and growth. One wouldn't want to invest in a volatile (otherwise known as "risky") investment if you think you will need that money again fairly soon, as then you might not be able to sell the investment at a high price (if the market is down).
Money market investments (e.g. fixed deposits) are the least volatile (often at a fixed interest rate).
Government bonds have a slightly higher return. Investing into a government bond means that the government owes you money—i.e. sovereign debt is held by private investors. The government pays back the bond when it matures, although in the meantime bonds are still traded (at prices relative to the final (fixed) value upon maturity). The difference between the value upon maturity and the current value gives the interest rate. A single government bond is often worth millions, so individual people typically only invest in these through a unit trust. The only risk to a government bond is that the government would default on its debt, but the government has such a large amount of surety from its tax revenue that this is an unlikely possibility (compared with a company defaulting on their company bonds).
Listed property is the next asset class, which grows more strongly than the previous two. Commercial property increases in value as the city it's in grows and develops, which increases the utility of the property.
While we are on the topic of investing in property, let me take this moment to talk about residential property. I believe that it is prudent to not buy a house while one is young, as that would restrict one from moving for one's career. Young people need to be footloose in order to start their career (there may be exceptions, if you have a career where you would never need to move to a different city). Buying or selling a house comes with huge costs through estate duties, so one shouldn't try to buy or sell a house more than twice in one's lifetime. Renting a house is the answer, and is not much more expensive than the running costs of owning a house.
Some people would respond that a house is a financial investment. My response is that it is foolish to invest all one's eggs in one basket. Diversification is always the rule of thumb to work with when investing; did you stop to think that a house is an extremely concentrated investment? What happens if the prices of houses fluctuate in your area? This video by The Economist indicates that the prices of houses may decrease when there is densification, or if more people turn to renting. Warren Ingram, in his book Become Your Own Financial Advisor (2013: ch 7), shows that the prices of residential property have a low growth rate: a real long term growth rate of 1.9%, according to the ABSA House Price Index. Compare that with listed property (commercial property ventures), which has a real long term growth rate of 6.4% (see page 82 of Ingram's book). So, listed property has higher growth than residential property, and if you invest in a property fund, you will most likely be choosing a diversified portfolio, which is not as volatile as a single property.
Lastly, equity is the highest-growth asset class, but also the most volatile. You can reduce the volatility of your portfolio by spreading your investments over hundreds or thousands of different stocks—this means your money is less at risk, although you will only capture the general market trend in share prices.
You should look at the proportions that each of these asset classes make up in a portfolio. Basically, you would want a higher proportion of your portfolio being allocated to the riskier asset classes if you're looking for long-term growth, but you would want a higher proportion of your portfolio being allocated to the more stable asset classes if you need short-term savings.
A good way to diversify is to expose your money to the global markets, e.g. through a global feeder fund. This works as a diversification strategy because overseas economies have slightly different cycles (ups and downs) to one's domestic economy, which offsets the domestic cycles. Most unit trusts have some global exposure, so you wouldn't necessarily have to worry about actively pursuing this diversification strategy if it is already built-in, but it is good to check how much global exposure the unit trust has. If you want to actively pursue a higher degree of global exposure, a "feeder" unit trust is one where the bank pools together rands from individuals (contributing in the local currency), and invests the whole fund in a global unit trust which is denominated in foreign currencies. In this way, the feeder fund exposes your money to the global market, without you having to exchange your rands for foreign currencies (which can be expensive).
SARS will tax your interest income above R23 800 at your marginal income tax rate. To calculate how this affects your return, simply multiply your nominal interest rate by 1-x, where x is your marginal income tax rate, to see what your after-tax nominal interest rate will be. Stocks and securities that don't earn interest will be subject to capital gains tax (CGT). R40 000 of capital gain is exempt from tax for individuals, but 40% (the "inclusion rate") of the remaining capital gain will be taxed at your marginal income tax rate. These taxes are fairly low, as they only affect the growth of your investment, not the initial capital. For example, investing in equity could give you about a 12% return—which would still be a high return of about 9% or 10% after tax (depending on your level of income). Nevertheless, you have two main options for avoiding tax: retirement annuities, and tax-free saving accounts. With any financial institution, you can choose to open these accounts, and you will choose unit trusts to underlie them.
The first is a retirement annuity (RA). Not only will you avoid tax on the interest and capital gains from investing in a retirement annuity (RA), but you can get a tax rebate for your contributions to the fund. Your personal income tax on that money will be delayed until you withdraw the money (after 55 years of age), by which time you'll have a lower monthly income flow than during your working life, which means that you'll pay a lower rate of personal income tax.
A retirement annuity would prevent you from withdrawing your savings until your older years, which helps if you have low self-discipline, but would not be suitable for shorter-term goals, such as buying a house. Not everybody invests in an RA, as employers often contribute to a company pension plan. If your employer matches your contributions, make sure to maximize that (it's free money!).
If you're still young, your marginal income tax rate is low, and you should be investing heavily in equity, a disadvantage with RAs is that Regulation 28 of the South African Pension Funds Act prevents RAs from having too much equity, or too much exposure to global markets. If you are young, with a low income, focus more on finding the best return you can get, rather than worrying about the tax on interest, as a retirement annuity may have less equity and thus offer you a lower return than high-equity funds that are subject to tax. RAs only make sense if you currently earn an income above that which you would have in your retirement.
Anybody who wants to invest in equity for their retirement should consider investing it tax-free. The government allows every person to save up to R36 000 tax-free per year, and up to R500 000 in one's lifetime. However, when you withdraw money from a tax-free savings account (TFSA), your allocation does not get replenished. When I buy my first house, I want to use up all my savings (because the interest on a home loan eats one's money). After I have paid it off, I will start saving for my retirement. Because of this decision, I only want to start using my tax-free savings allocation after I pay off my house, as I think I will live for a longer period between paying off my house and my retirement, than between now (my youth) and buying a house. A longer amount of time my money is spent in TFSAs after I pay off my house will mean a higher amount of interest earned tax-free.
Smoothing monthly income
I have wanted a product such as a two-week fixed deposit, so that I can responsibly put aside money for the second half of the month, after receiving my salary. Alas, no such product exists. Standard Bank's one-week notice account lets one withdraw money instantly at a fee, which does not restrain a lack of self-control, although I have not opened an account with FNB yet (they also offer a 7-day notice account).
However, I have formulated a solution. Nedbank clients can have multiple notices of withdrawal on a 32-day notice account. So, in order to manage my money, I can put money into my 32-day notice account, from my salary, and make a notice for the 16th in one-and-a-half months' time. When I do that again at the end of the following month, there will be more than one standing notice, but I would receive the money from the previous notice in only half a month's time. This is a golden nugget that I wish other people had helped me discover or encourage earlier. I could consistently follow this behaviour by having an automatic recurring transfer from my transactional account to my 32-day notice account, on my salary date.