South African investors who rely on low-risk, interest-bearing investments have found themselves struggling in recent years.
In 2020, the South African Reserve Bank (Sarb) reduced the repo rate by 3%, bringing this down to a record low. This was done to support the economy in response to the Covid-19 pandemic.
Prior to this, South African investors, and particularly pensioners, had been spoiled by high real interest rates for quite some time. Not only were South African interest rates high compared to the rest of the world, but even ordinary money market returns had been beating inflation over the preceding five years. For example, the PSG Money Market Fund returned approximately 6.20% per annum over five years compared to the inflation rate of 4.30% per annum over the same period.
The dangers of chasing returns
We moved quite rapidly into a ‘valley’ of low-interest rates. When this happens, investors are forced to start looking for alternative options and this, in turn, creates other risks. Firstly, investors confuse their short-term goals with their long-term goals. Secondly, they find themselves in a mindset of pursuing higher returns without having to take the additional risks into account. The sharp recovery in the stock market over the past year could rapidly influence investor appetite for additional risk. Thirdly, this environment creates an ideal breeding ground for investors to be misled in their search for investment products that guarantee higher returns. South Africa has seen far too many examples of pensioners and savers having to tighten their belts due to over-promising and, in some cases, unscrupulous providers. It seems inevitable that blind spots such as these will re-appear in the future.
Separate short-term goals from long-term goals
It is extremely important to set clear goals for your investment capital for it to be able to meet your diverse needs. Short-term needs usually include provision for income, an emergency fund, and specific expenses that will arise for vacations, vehicles, and the purchasing of property.
Here, the options are largely limited to ordinary savings accounts or money market investments that should see you earning between 3.50% and 4.50%. Low rates such as these might be disheartening, but this is the price you pay for the liquidity of your capital. The goal here is not to chase returns, but rather to ensure access to your capital.
Once you move further up the yield curve, you can start looking at fixed-term options or unit trust funds with a longer investment horizon, even though these do involve a degree of capital risk in the short term.
SA Retail Government Bonds, meanwhile, now offer a return of 9.25% over five years. Pensioners aged 65 and older can achieve these returns almost tax-free by making use of their annual R34 500 interest exemption on a maximum amount of R370 000. Depending on your personal tax rate, you can invest even more in such products without any effect on your tax liability. However, if you already fall into a higher tax category, this option begins to look less attractive. Another example of a fixed-term investment is that offered by Capitec bank where you can lock in a return of 8.89% over a period of five years.
Of course, these returns do not come without risks and this must be weighed against each investor’s individual needs and circumstances.
Regarding unit trusts, there are funds available made up of cash along with corporate and government bonds. An example of this is the PSG Wealth Income Fund of Funds, which is exposed to a wide range of asset managers, allowing you to benefit from a variety of approaches and to diversify your risks further. This fund’s yield over five years and longer has averaged 7.6% per annum before deduction of advisory and administrative costs.
There is a fine line between looking at alternative investments to achieve better returns and taking on excessive risk chasing higher returns irresponsibly. However, in order to gain access to potentially better returns, you need to accept a higher level of risk. You should guard against allowing the low-interest-rate environment to push you into taking risks that are not in line with your needs and circumstances.
A well-considered investment portfolio, composed of cash, bonds and real estate, along with local as well as foreign equities, should yield better returns for you over the long term. Should the provision you have made for your short-term needs seem excessive, please feel free to contact one of our advisors at PSG Wealth Pretoria East to ask about alternative options.