Savings / Investment Vehicles
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.
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.
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.
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.
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:
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.
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.
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.
There are numerous ways in which property can be purchased but some of the more common routes are:
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:
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:
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.
Apart from legislation and regulations governing pension and provident funds, the rules of each specific fund guide the members’ interaction with the fund.
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.
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.
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.