In an era of constant cellphone connection, T20 cricket, and skyrocketing ADD diagnoses, our generation has become fixated with the notion of ‘gratification on demand’.
The grand ideas of slowing down and enjoying the journey and achieving a goal through incremental gains seem to resonate very little with today’s culture.
I see the influence of the instant gratification expectation in the realm of wealth and investments. I recently overheard a millennial emphatically declare: ‘You cannot save yourself rich!’.
The truth is, with time and consistency, every one of us can save and accumulate meaningful wealth.
‘Saving yourself rich’ is possible with a sensible approach that recognises that exhibiting restraint when needed is highly beneficial (this applies to all areas of our lives). These two decisions will help you get there.
Decision 1: Start saving now!
Oftentimes we believe that there is no point to saving because we do not have enough funds. But, far more important than the amount saved, is simply the practice of saving regularly, and these scenarios show you why.
For both of these examples, assume a 10% investment return per year.
When Jabu is born, his parents set up a R500 monthly debit order into a unit trust in his name. When he graduates from university at age 21, Jabu very diligently continues to save R500 monthly until his 65th birthday.
The total contribution over the 65 years is R390 000.
At 65, Jabu has accumulated a whopping R38.8 million, when the accumulated interest is included. Yes, you read that correctly.
Now let’s meet Marie. Marie is born the same year as Jabu, and graduates at the same time. She likes the idea of saving R500 per month. She starts the monthly premium at age 21 and keeps this up until her 65th birthday.
In the 44 years of saving, Marie contributes a total amount of R264 000. The value of her savings at age 65 is R4.7 million.
To try to close the gap, what if Marie had started a monthly contribution of R2 500? That is five times the amount that Jabu is paying.
By paying a monthly contribution of R2 500 for 44 years, Marie would have accumulated an impressive R23.7 million … still R15 million less than Jabu’s value.
These two scenarios – both featuring young and committed investors – clearly illustrate the huge value of committing as early as possible with a savings regime … simply by the contrast of the final total amount.
Decision 2: Where to save?
If you commit to accumulating savings on a regular basis, you will need to consider the appropriate investment vehicle. The two questions to ask about any investment vehicle are:
- How will my money be taxed in this vehicle? Any tax you may have to pay will, naturally, erode the growth. If you can mitigate this liability, then you should take such advantage.
- What are the costs associated with this vehicle? Not all products are equal in the world of investing. It is important that you question the ongoing fees associated with the administration of your money.
You can choose any of the following vehicles:
Tax-free savings account
For all South Africans, this is the first option when you are looking for a long-term investment. It is offered by banks and asset managers and is easy to access.
There are limitations on the amount one is allowed to contribute to this vehicle, namely:
- R36 000 per year to a maximum of R500 000 in a lifetime.
- Sars levies a tax of 40% on any contribution which exceeds the annual limit of R36 000.
Tax: there is NO tax on the growth within this fund and there is NO tax on the withdrawal.
Unit trusts offer a wide range of investment options, making it a very flexible mechanism to access markets. Money is not ‘tied up’ and the investor has access to the funds on instruction without fear of contractual penalties. Because the tax is payable in the individual’s hands, it is important to consider the effect of annual exemptions and deductions with regards to income tax.
Tax: All tax is payable in the investor’s hands. Income, dividends and capital gains tax is applicable.
An endowment is issued on a life insurance licence and is governed by Section 54 of the Long-term Insurance Act. There is a five-year restriction period of access to funds; within this restriction period, the investor is allowed one withdrawal and one surrender.
Therefore, liquidity is a big consideration here. There is the potential of a penalty (percentage of investment value) being applied if the contract changes, such as surrendering the policy, reducing or stopping monthly contributions.
Tax: Investment return is taxed according to the five-fund approach for taxation. There is a set percentage, depending on whether the investor is an individual or company or trust or retirement annuity fund.
For individuals with a high marginal tax rate, this offers an opportunity to reduce tax as the income tax rate is 30% and capital gains tax (CGT) of 12%.
A retirement annuity is a retirement fund and is governed by the Pensions Funds Act. This investment vehicle offers not only a tax-free environment but also a tax incentive (to a maximum limit) on annual contributions.
Once the funds are allocated to a retirement annuity, the investor has no access to the funds until age 55 (there are very specific circumstances where money may be available).
The ability to invest in various assets is strictly regulated; the main restrictions are that you are only allowed a maximum of 30% of the assets to be invested in foreign assets and a maximum of 75% to be invested in listed equities.
Tax: There is NO income tax, dividend tax or CGT payable.
However, when the investor achieves age 55 or older and chooses to access the funds, there are limitations on how much you can withdraw. You can only withdraw a maximum of one-third of the fund value with the balance to be used to purchase a compulsory annuity. The lump-sum withdrawn is taxed according to the retirement tax table. The income from the compulsory annuity is taxed as income.
Enjoy the journey!
As you can see, the ability to ‘save yourself rich’ is well within your control. If there is an investment that promises to make you rich overnight, please hide your wallet and run away. It is probably a scam.
Like good wines, happy relationships and learned skills, consistency and time are the proven attributes to development and moving forward. The habit of saving is the most important decision to create wealth. As illustrated in the scenarios, it can be as little as R500, even R100, a month that, with time, can generate meaningful wealth.
It is not how smart you are. It is not how lucky you can be.
It is how committed you are to a savings regime that will reap the ultimate reward.