January is considered the longest month on the calendar in terms of stretching your salary. And with a new year comes new resolutions, with the best intentions for the year ahead whether it may be regarding our personal finances, fitness or friendships … the list goes on. With the focus more specifically on investments and personal finances, our own best intentions might sometimes have adverse results on our own financial wellbeing.
There are different reasons that this might happen, we might be too optimistic regarding certain investments, we might not do thorough due diligence on the investments, or it may well be one of the thousands of new years resolutions that are already forgotten after the first paycheque has landed.
These are general investment and financial mistakes that we tend to make most of the time. If you are careful in your approach and prioritise some of these points below, you will give yourself a better chance of bringing your financial new year resolutions to fulfilment.
1. High initial fees
One way to squander your returns is to invest with an advisor or large insurance outfit focused more on their financial benefit than your well-being.
All too often, retirement products are structured around their needs such as earning upfront commissions and fees. You must also ask whether the institution’s attention is sufficiently focused on managing your portfolio vs their primary business, for instance, short-term and life insurance.
The biggest danger is that you are sold a product or investment that is not managed appropriately, which could mean you will miss your retirement goals.
My advice: rather steer clear of brokers and insurers who have a greater interest in earning commissions and fees than looking after your investment portfolio.
2. Steer away from investments you do not understand
This sounds like common sense, but the explosion of cryptocurrencies and meme stocks seems to have clouded many investors’ minds.
The problem with many of these fads is that they are not legitimate investments. Look at our homegrown Bitcoin Ponzi scheme Mirror Trading International that duped some 260 000 investors out of 23 000 Bitcoin.
The promise of great riches from schemes that sound too good to be true almost always is.
My advice: always be clear about what the underlying asset is that you are investing in. A legitimate financial advisor should be able to do so easily by showing you the funds and the assets that they hold.
3. Cash and money market investments
Interest rates are currently simply too low to justify holding significant amounts of capital in cash or money market instruments for the long term.
It makes sense to have short-term capital in these safer assets if you are saving for a short-term goal or have an investment horizon of less than 18 months.
But, unless you are holding this money in reserve as dry powder to take advantage of investment opportunities, you are doing more damage than good to your portfolio.
My advice: If you have a long-term view, and your goal is capital growth, then you will need to strongly consider higher-risk investments.
4. Tax-free savings accounts at commercial banks
I’m of the opinion that the naming of Tax-free savings accounts (TFSA) does no justice to this product that it should rather be labelled as a tax-free investment account.
That is to say, if you do not take up accounts offered at the main street banks because their annual returns of around 5%-7% simply do not offer any meaningful value after costs and inflation.
The aim of TFSA’s is to encourage South Africans to save by offering a vehicle that can deliver long-term capital growth without sacrificing any gains to Sars. The secret to using this vehicle is the ability to leave the money untouched for as long as possible – more than 15 years will be ideal.
My advice: Rather invest in a tax-free investment account available on dedicated investment platforms like Momentum Wealth, Sygnia or Ninety One. These funds have shown much higher returns in the region of 10% and more.
5. Retirement annuities for young individuals
A retirement annuity (RA) is the go-to solution proposed by many advisors, usually those associated with large insurers.
One of the big selling points is that they offer ‘tax-efficient investing’ because of the monthly rebate, but they also come with limitations that you need to be aware of. And because of these limitations, I believe that younger investors should avoid these investment options for the time being.
Here is my reasoning:
RAs need to comply with Regulation 28 of the Pension Funds Act that limits how much offshore exposure is allowed in the fund. This has led Regulation 28 funds to drastically underperform over the past decade.
One other drawback is the possibility of changes in legislation (as is already on the cards) that could further limit your choices.
The reason I suggest that young investors avoid RAs as a retirement planning option is because the tax advantages are insignificant when you are earning an entry-level salary.
And then, your capital is tied up in the RA until you are 55, and when you retire you have no choice but to move at least two-thirds of your capital into a living annuity. Thanks to recent legislation, you will not be able to get any of your capital in an RA for three years after you emigrate from South Africa.
So, there are many more factors to consider than simply a tax deduction.
My advice: Young working adults would be better of putting their money into a TFSA that offers 100% offshore exposure with much healthier tax advantages in future.
Give yourself the best chance to reach your financial goals in the coming year by keeping the above pointers in mind when reviewing your investment portfolio.