Despite the fact that most assets depreciate over time, there are some hard assets that have the ability to maintain value and sometimes also provide an income. Examples of hard assets investors have used as a savings tool include tank containers, coins, carpets and aeroplanes.
These hard assets often take the form of collectibles on which people place a high value, despite the passage of time. Carpets and coins tend to increase in value over time. The other set of hard assets investors put their money in are assets with long service lives. Items such as tank containers and aeroplanes take a long time to completely depreciate. These assets also tend to provide impressive income streams over their service period.
These assets are obviously not for the average investor. The capital required to purchase many of these items is beyond the reach the average South African income earner. Nevertheless, investors can pool their resources for the purposes of attaining these assets.
Most people have some form of bank savings account. Because of their simplicity and familiarity, a large portion of the public’s savings is tied up in bank investments of one type or another.
There are different types of bank investments, and below are examples of a few.
- Call Accounts Almost every bank offers some type of call account. With these accounts the investor’s money is on call, which means it can be withdrawn at very short notice (usually not more than 24 hours). Interest rates fluctuate while the investor’s money is invested.
- Fixed Deposits With fixed deposits, the investor’s money is tied up for a pre-specified term, usually ranging from one month to five years. Although interest rates are usually fixed at a pre-determined rate for the full term, some banks are now offering linked deposits, where interest rates can increase during the term, but has a guaranteed minimum. Interest rates on these deposits are generally higher than those on call deposits, and the longer the term the higher the interest rate.
- Notice Deposits With notice deposits, an investor’s money is invested indefinitely and only becomes available after a pre-specified notice period (eg.32 days) has been served. Interest rates on such investments are generally higher than for call deposits, and the longer the notice period, the higher the interest rate.
Bank investments have minimum investment amounts that vary from institution to institution, but entry levels are generally low compared with alternate investments. However, interest rates differ quite substantially for different amounts – the larger the amount deposited the higher the rate.
There is very little risk of an investor not getting their capital back from the bank. Banks in SA are well regulated, and there is very little chance of an investor losing their money.
Direct JSE Investments
The Johannesburg Stock Exchange (JSE) is the ultimate home of more than half the total investments in South Africa. An individual may invest in shares in different ways. In fact, ownership of an insurance policy or units in a unit trust fund, relates to ownership in shares on the JSE. This is because most insurance companies invest a large portion of their policy-holders’ money in shares on the JSE.
An investor may invest in a portfolio through a stockbroker, or visit a bank and invest through an investment consultant. An investor may manage the portfolio personally by dictating to the stockbroker what shares to buy and sell. The stockbroker will buy the shares on the investor’s behalf. A stockbroker then charges a negotiable brokerage fee plus VAT and duties.
The JSE offers protection to the investor against possible fraud by stockbrokers through their guarantee fund of approximately R80m in assets to which an investor may apply for compensation.
It is also now possible for investors to open an account with a stockbroker via the internet. This account would be password protected. Buying and selling instructions are given by e-mail to the stockbroker who buys and sells the shares on the investor’s behalf. The investor pays by bank transfer to the stockbroker’s account.
An investor may invest in a managed portfolio through a stockbroker, a bank, a trust company or a portfolio manager. There would be an agreed fee for the management of the portfolio and a portfolio management contract would be signed. Portfolios must be classified as discretionary or non-discretionary. In the latter case clients must be contacted before the managers buy or sell. The method of fee taking must be disclosed and varies between institutions. Fees usually include 1% of the portfolio’s value taken annually plus a percentage of profits earned.
While most stockbrokers insist on minimum investment amounts, some do specialise in smaller accounts and theoretically one can own shares with very little outlay. In order to spread risk, the investors must have at least four or five different shares. Also, one should never purchase less than 100 shares in a company (this is referred to as an odd-lot in the industry) as these can often be difficult to re-sell.
Endowment policies have been around for a long time. They are governed by the Insurance Act and are available from assurance companies only. Endowments are available for recurring premium as well as lump-sum premium investments. Endowment has fallen a little out of favour in recent years, mainly because of a lack of transparency in terms of cost and performance when compared with investments like unit trusts. Endowments are essentially pure investment policies, although life and disability benefits can be added if required. These funds are invested in an underlying portfolio, and a wide range of portfolio options which differ from company to company are available.
There are variations in the types of endowment available, and the differences are outlined below.
- Smoothed-bonus portfolios Smoothed-bonus portfolios aim to minimise the extremes in year-to-year returns. In the good years the fund manager keeps some of the growth in reserve, which can be called upon in bad years. The growth comes in the form of bonuses that are declared annually by the assurance company. In addition, these portfolios carry guarantees so that at the end of the contract term the investor will receive an absolute minimum of the original capital plus growth of 4.25% per annum.
- Market Portfolios Unlike smooth bonus portfolios, market portfolios do not offer any level of guarantee. Some assurance companies do, however, ensure that profits earned in any particular year are ‘locked in’ and that only the current year’s profits are at risk. Market portfolios include all sorts of options ranging pure equity portfolios to conservative portfolios.
- Specialist Portfolios In addition to the above portfolios there are also portfolios such as property portfolios and small company portfolios. In order to compete with the unit trust industry, more and more portfolio choices are being made available. There is now also the option of linking one’s endowment to unit trusts.
- Offshore Portfolios Endowment policies were one of the first few investment vehicles that were able to invest offshore after the partial lifting of exchange controls in 1995. In the same manner as offshore unit trusts, these portfolios can invest money in foreign markets. Although the portfolio is invested in foreign assets during the period of the investment, it is converted to rands at maturity.
- Guaranteed Endowments With these policies, a quote is obtained at the time of investing and a maturity amount is guaranteed at the end of the period. This amount cannot be more or less than quoted, regardless of market conditions. Generally, the effective rate at the time of quotation is affected by prevailing interest rates – the higher the interest rates at the time, the higher the maturity value. These investments offer the least risk of all and are one of the very few investments that guarantees not only capital invested, but growth as well.
- Matured Endowments This investment vehicle is sometimes also known as a second-hand policy. The principal difference with the other endowments is that these are portfolios that have already run for five years. In terms of current income tax legislation, any endowment policy, which has run for five years, is not restricted in the number of loans or part surrenders the holder can exercise on the policy. The holder can therefore withdraw capital form the policy as and when needed in order to cover living expenses. Generally the minimum amount required for a single-premium endowment policy is R10 000.
A unit trust, or mutual fund, is a unitised portfolio of investments that is managed by a fund manager according to a pre-specified mandate that spells out the objectives of the portfolio. The industry has been successful abroad and has gained popularity as an investment vehicle in SA.
A unit trust fund is called an ‘open-ended’ investment fund. This means that more units are created every time people invest money in a unit trust. The value of the unit is determined by the underlying value of all the assets of the particular fund, divided by the number of unit trust holders. The total value of the pool of shares and other investments held by the unit trust fund is calculated every day. The value is determined by the level of the share prices, or the value of the other investments held by the fund. The total value of all the assets held by the fund is then divided by the number of units owned by investors.
Minimum lump sum amounts for unit trust are low, although they can be slightly higher if going through some of the linked-product providers. Unit trusts also offer attractive monthly investment options.
There are as many levels of volatility risk to unit trusts as there are types of unit trust. Money-market unit trusts show very little volatility, whereas specialised equity funds show a high degree. Even then, due to their spread over a basket of shares, equity fund unit trusts generally show less volatility than investing in a single share on the JSE. Unit trusts also do not offer any level of guarantee.
A wide variety of unit trust funds are available in SA and there are increasingly varied ways of purchasing them. In their simplest form, units in a unit trust can be purchased directly from the unit trust management company (Manco). Unit trusts are broadly categorised according to their investment mandates. In addition to purchasing unit trusts directly from the management company, there are now several alternative routes into unit trusts, such as those offered by the linked-product industry.
- Linked-product Industry The linked-product industry is fast becoming the preferred route into unit trusts and already accounts for over 45% of new investment inflows in South Africa. In this arrangement, the linked product provider (LPP) acts as a central administrator of unit trust portfolios. Instead of an investor holding unit trusts with several different management companies, they purchase all their unit trusts through the LPP who has contracts with the management companies. The LPP channels the funds through to the management companies, which then invest the money in underlying unit trusts. The LPP therefore acts only in an administrative capacity and does not have any bearing on the underlying unit trust performance. The advantage of choosing an LPP is that the LPPs have structured a wide range of products, such as retirement annuities, pension and provident funds, life annuities and income plans, through which unit trust funds can be purchased. Unit trusts can therefore serve as the underlying investment portfolio for all sorts of voluntary and compulsory savings schemes. LPPs act almost as wholesalers of uit trusts and can therefore switch the investor from a fund of one management company to another for a very low switching fee.
- Fund of Funds A new entrant into the unit trust industry is the Fund of Funds. This product is a fully registered unit trust in its own right, but unlike the ‘standard’ unit trust which invests in shares, bonds or money market instruments, this unit trust invests in a collection of other unit trusts.
- Multi-Manager Funds The traditional unit trust usually has one manager who makes all the investments in that unit trust. The manager is responsible for the investment in money-market instruments, bonds and gilts, and all types of equities. The manager therefore needs to be somewhat of an all-rounder. In reality, however, some managers have a flair for niche investment areas, such as bonds, small companies, or IT companies. Instead of having one manager to manage the entire portfolio, multi-manager unit trusts employ bond specialists to manage the bond component, small companies specialists to manage the small companies component, and IT specialists to manage IT.
- Wrap Funds Another variant within the unit trust sphere is the wrap fund. This arrangement has grown as an extension to products from LPPs. Many independent brokerages manage large numbers of LPP portfolios on behalf of their clients. Running too many individual portfolios becomes administratively inefficient and brokers often consolidate all of these individual portfolios into four or five combined (wrapped) portfolios according to different risk profiles. These managed portfolios are known as wrap funds.
The advent of capital gains tax (CGT) on 1 October 2001 has threatened the existence of many of these wrap funds. Wrap funds are not regulated entities, so they become liable for capital gains tax every time they sell out of an underlying unit trust and realise a capital gain.
Guaranteed products have recently entered the South African investment arena and come in all sorts of shapes and variations. They essentially all boast the following features:
- They are five-year investment policies
- The investment performance is based on a specific local or international stock market index stock market index (or sometimes a combination of these indices)
- The investment performance can be geared (for example you can get 1.5 times the underlying index performance) or capped (for example, even if the underlying index achieves 30% growth in a year, your share is limited to 25%)
- The original capital invested is guaranteed ( in other words, the worst you can do in five years, even if markets go downwards during the whole period, is get you money back)
- In certain instances additional lock-in guarantees are offered whereby the growth portion is guaranteed (locked-in) once it reaches a certain level.
- These products are sold in tranches (batches) which are only available until the particular batch is sold out or until a certain date has been reached.
The internal structure of these products is very sophisticated. They make extensive use of derivatives that enable the guarantees and the gearing offered. The first tranches were launched in SA in1997. Since then there has been a flurry of new products onto the market with ever-changing features and names.
There is constant innovation in the guaranteed products industry, and this has ensured that the variety of products is bewildering. The main variations relate to the index to which the product is linked and the different levels of gearing, capping, guarantees and costing.
The minimum investment varies from company to company, but us generally in the region of R25 000.
These products are usually underwritten by large international banking groups, which have the resources and the expertise to structure them. Some of these banking groups are larger than South Africa’s top 10 companies combined and the solvency risk would appear to be very low.
Stokvels / Credit unions
A stokvel is a savings scheme by group of people who save a regular amount each month, say R100.00. Each person then gets a chance to have the month’s collected cash. Urban legend has it that stokvels are so addictive that members sometimes save enormous amounts relative to their earnings.
Recently, the government, through agencies such as the National Urban Reconstruction and Housing Agency (NURCHA), developed programmes that will secure housing loans for people earning less than R2000.00 a month who have a proven track record of saving through schemes such as stockvels. Low-income families have been saving through stokvels and burial societies for a long time. It is estimated that there are at least 2000 stokvels in the country.
Minimum investments into stokvel investments are very low – in fact, they are at the discretion of the people forming the stokvel. However, an important element of the stokvel model is trust. Members have to be fairly confident that the other members will keep up their monthly payments, especially after having received the cash.
- Credit Unions Members with a certain common bond may get together to start a savings and loans scheme. A strong sense of trust is important as loans are made available to members after a predetermined period of saving. In South Africa the credit unions are governed by the Savings and Credit Cooperative League of South Africa (SACCOL). Saccol is affiliated to the African Confediration (ACCOSCA) and the world body, the World Council of Credit Unions (WOCCU).
Property is one of the oldest form of investment there is. It is an unusual type of investment as there are often misunderstandings about owning a property.
- Paying off a bond Homeowners who come into a lump sum often believe that settling their bond is a form of property investment and must be decided upon according to the pros and the cons of investing in a property. This is a misconception: the decision whether to invest in property or not was already taken when you purchased the property in the first place. Settling your bond is an investment in debt settlement and must be dealt with according to the merits of debt settlement alone.
- Buying a home If you do not already own a home and are living in rented accommodation, then the decision whether to invest in property or not, cannot be based on financial consideration alone. There are lots of invisible factors such as lifestyle and personal preferences that cannot be measured purely in monetary terms.
There is one school of thought in the financial advisory community that advocates that property investment of any kind (including owning your own home) is not viable. However, some of the benefits of owning your own home include the following:
- sense of security
- reduction of relocation costs – people with leases often have to relocate when they expire
- home improvements
There are numerous ways in which property can be purchased but some of the more common routes are:
- Residential property A second residential property can be rented out for income purposes or to cover all or part of the bond repayments. Capital gains (or losses) can be made upon the sale of the property. This is one of the most common forms of property investment.
- Commercial or industrial property This form of investment is more specialised and usually requires larger amounts of capital. Properties are rented to commercial or industrial tenants and income and capital gains stand to be made. This route can often include running your own business from the premises. Perhaps you are already in business and decided to purchase your own premises as opposed to renting from a landlord. You could also purchase a freehold business such as a hotel or a service station where the property is included with the business.
- Property syndication One of the ways to counter the large entry costs for commercial and industrial property is for investors to pool their money and buy property together. This can be done on a very informal basis (eg between a few friends) or it can involve buying into a professionally managed property syndication whereby a financial institution puts the whole scheme together and manages and administers it.
- Land Another route into the property market is by purchasing land. This is generally highly speculative and although fortunes can be made by buying in areas that later become popular. Bare land does not generate any income at all, and the loss of potential interest on the capital needs to be considered.
- Property Trusts These investment vehicles are a combination between a unit trust and a share on the JSE. Like unit trusts they pool the funds of many investors and purchase a portfolio of suitable properties (as opposed to a portfolio of shares). They differ from normal unit trusts in that they are closed-ended entities and can only raise additional capital by issuing rights to buy more shares.
Purchasing a property individually requires a relatively large amount of capital unless you go the syndication or property trust route. There is, however, a unique feature of property that is relevant here. Property is one of the few investments where finance is easily and readily available.
The chances of a property investment going insolvent, depends entirely on your (or your tenant’s) ability to repay bond repayments. Individual properties in particular localities may be the source of exposure risk to the investor.
Until 1996 the stringent exchange controls that were in effect in South Africa ensured that the South African investor was totally isolated from the rest of the investment world. This has had serious consequences for many investors’ portfolios, especially if o9ne considers that diversification is one of the most important principles of investing. The JSE’s capitalisation is less than 2% of the world total. This is not only a tiny proportion of the capital of the world, but it is a proportion made up of an emerging market economy, which in global financial terms is a high risk area.
The bottom line is that having all your wealth (and this includes property, cars etc.) tied up in one currency, one stock exchange and one economy does not make good investment sense. Considerable research has been done by international experts, and there is a fair amount of consensus that the SA investor should have between 20 and 35% of their assets offshore. At present every South African investor is allowed to invest R750 000.
The only legal way to get your money abroad (in your personal capacity) is to apply to the Revenue Service for a tax clearance certificate, which must accompany your offshore investment application. Provided your tax affairs are in good order, the Revenue Service will issue clearance for an amount of up to R750 000 per tax payer. This certificate is valid for three months from date of issue. A husband and a wife can therefore invest R1 500 000 offshore between them. Indications are that this amount will be increased over the next few years until eventually there is no exchange control in South Africa.
Once the tax clearance certificate is obtained, foreign exchange forms need to be completed and the rand amount converted into the chosen currency and sent by your local bank to the foreign investment company’s bank account overseas. Although there is a lot of paperwork, the entire process is very swift.
Another method of investing offshore is the use of rand-denominated offshore unit trusts. These products are offered by local unit trust companies, and do not require as much paperwork and administration.
Going offshore opens a wide array of investment opportunities, and below are a list of some of the offshore investment vehicles available:
- offshore bank accounts
- offshore equities
- offshore unit trusts
- foreign endowments
- foreign guaranteed products
- foreign property
Most offshore investments have considerably higher minimums, due largely to a weaker rand. Although £10 000 might be a small amount of money to a British investor, it equates to more than R100 000! There are, however, certain offshore investments that will accept as little as R10 000.
There is a false perception among SA investors that offshore investment is high risk in nature. The feeling is probably fostered by the discomfort of having your funds thousands of miles away. Off course there are risky investments, but most of the large and reputable international firms are much more solid than the largest South African companies. There is, however, currency risk. The fact that international losses can be magnified by strength in the rand is worrying.
Most other investment vehicles are passive in nature. Investing in your own business usually requires much more active involvement. Nevertheless, upon coming into a lump sum many people consider the merits of investing in their own business. Setting up a new business is a very complex issue. Once satisfied that your business is attractive from an investment perspective, many other important issues, some of them not even financial in nature, need to be considered.
There are many routes to investing in one’s own business. Some of these include:
- Setting up the business from scratch – probably the most challenging route, as it involves venturing into the unknown.
- Buying a franchise – Usually entails paying considerable goodwill. A proven franchise has proven products, with proven marketing methods and track records.
- Buying into an existing business – this option is less risky than starting up your own business. However, you have to make sure you are not buying anybody else’s problems.
- Investing in a partnership – another alternative is to invest in a portion of a new or existing business. This van help to spread the risk and workload.
- Setting up a sideline business – people going into retirement often do this. They set up a little business, often in a field that started out as a hobby or interest, to generate earnings to supplement their income.
- Expanding your existing business – the questions that must be asked here are: is expansion necessary? Is it viable? etc.
The amount of capital required to successfully start your own business is usually fairly high, and just about always underestimated by the budding entrepreneur. It is also important to note that the investment is not limited to the money you are putting into the business. With most small businesses there is a large amount of personal liability as well. This liability will be in the form of sureties that may be taken out.
Small businesses also carry quite a large amount of solvency risk, and investors have to be aware of this. Also, insolvency may not be limited to the investment you have made in the business, but can result in the loss of other assets that you own, such as your house or car.
An investment trust is a unit trust in a slightly different guise. The key difference is that it is a closed-ended unit trust. The fund has a finite number of units, and these cannot be created or cancelled. The distinction between investment trusts and unit trusts centres on how units are traded and how their price is determined.
The most common form of investment trust is in fact not a trust structure but that of a company. The shares or units of investment trusts are traded on the stock exchange. The price of units depends – as with company shares – on what buyers and sellers believe the units are worth in relation to the trust’s assets and earnings potential.
Investment trusts are traded on a stock exchange, despite the fact that they are similar to unit trusts. This means that the entry costs are higher than unit trusts, because the investor would have to work through a stockbroker. The fact that shares are often traded in large lots also affects the liquidity of investment trust units.
Pension / Provident Funds
There are three types of retirement funds: two of these are the pension fund and the provident fund. Pension and Provident Funds are employer-based schemes because only an employer can initiate them. A retirement fund must be registered by the Financial Services Board and approved by the South African Revenue Services to obtain the necessary tax benefits provided to retirement funds. All these funds run under a trustee arrangement where the trustees manage the fund and take care of the interests of the members.
- Pension Funds The pension fund receives contributions during a member’s employment and provides for the payment of a pension on retirement. The member may, however, commute up to a maximum of 1/3rd from the pension benefit as a lump sum and receive the balance of 2/3rd in the form of a pension. The member’s decision to commute or not, will depend on their personal circumstances and tax benefits available at the time of retirement.
- Provident Funds A provident fund structure makes provision for the fund to receive contributions while the member is still in employment. On retirement the member is entitled to receive the full benefit available in the form of a lump sum. The member is not obliged to receive the full benefit as a lump sum, but is entitled to utilise a portion thereof to purchase a pension. This entitlement to utilise the pension option needs to be built into the rules of the fund.
Apart from legislation and regulations governing pension and provident funds, the rules of each specific fund guide the members’ interaction with the fund.
Preservation funds are not available to investors for direct investments. This investment vehicle is only available to members of pension or provident funds who are terminating their employment and who wish to preserve their benefits for retirement. Preservation funds have the same attributes and characteristics of the pension and provident funds they emulate. The key difference is that they only take one single contribution in the form of a transfer from a pension fund or provident fund. Members are not allowed to make any further contributions. The second anomaly is that members of a preservation fund can gain access to their funds on one occasion prior to the stipulated retirement date.
A retirement annuity is a private pension fund. Members are entitled to contribute to a retirement annuity until the age of 70. Members are only obliged to receive their benefit at the age of 55 and they are obliged to take their benefit by age 70. This provides a window between the ages of 55 and 70 to plan the payout from a retirement annuity fund.
Similar to a pension fund, a retirement annuity compels members to take at least 2/3rd of the value of their benefit at retirement in the form of a pension. This enables members to commute up to 1/3rd of their benefit as a cash lump sum.
Compulsory / Living Annuity
On retirement from a retirement fund a compulsory annuity / pension is spawned. This investment option can only be accessed on retirement from a retirement fund. A compulsory pension pays the retiring member a regular monthly or annual payment in the form of an annuity / pension.
There are two types of compulsory annuities. They are the traditional annuity where the retirement fund or the insurer specifies a monthly to the member and guarantees this payment. Here the fund /insurer carries the risk.
The second alternative is the living annuity. The member places the retirement benefit into an investment portfolio and nominates a monthly payment between the parameters 5% and 20%. The member takes the investment risk. Should the specified monthly annuity payment exceed the investment performance, there will be an element of capital depreciation within the portfolio.
Living annuities have become popular due to their flexibility in the selection of an income and the investment control they offer. However, the most significant benefit is in the protection of capital in the event of the member’s demise. In a traditional annuity the capital is forfeited in the event of a member’s demise. In the case of a living annuity, the capital is never lost and can be bequeathed.