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Questions to consider before you start investing

Understanding your reasons for investing, what you hope to achieve with your wealth, and how your investment fits into your overall financial portfolio are critical for success.

Investing is one of the surest ways to build wealth, but understanding your reasons for investing, what you hope to achieve with your wealth, and how your investment fits into your overall financial portfolio are critical for success. Before you start your investment journey, consider the following questions:

Why do you want to invest?

At the outset, be clear as to your motivations for investing. Do you want to create long-term, sustainable wealth? Do you want to speculate for some quick financial wins? Do you simply want a place to house your surplus income? What does financial freedom mean to you? How much money would make you happy? Are you innately frugal? Is FOMO making you want to jump on the crypto bandwagon? Finding answers may require deep self-reflection but identifying the driving forces behind your decision to start investing has bearing on how and when you implement your investment strategy.

What do you want to use the money for?

It is important to be clear on what your investment is earmarked for, and this can be established through a simple goal-setting exercise. Do you want to save for a deposit on a property, pay cash for a car, enjoy an overseas trip, save for your child’s tertiary education, or fund for your retirement? The purpose for which you intend to use the money will, amongst other things, have a direct bearing on the type of investment vehicle you employ. For instance, a retirement annuity structure would be best suited for retirement savings, a tax-free savings account may be best for your child’s education money, a unit trust portfolio would work well to save for a deposit on a property, while you can effectively use a money market fund to store cash for next year’s travels.

When are you likely to need the money?

Understanding your investment timeline is another critical factor when putting an investment strategy in place. If you’re saving for the long term with a time horizon of ten years or more, it’s likely that you can expose your capital to more investment risk by investing in growth assets such as equities and property. As an investor, you essentially have the option to invest in equities, property, bonds and cash – or a combination of the above – and how you choose to structure your portfolio will depend largely on when you need to access the money. If you invest purely in equities, you can expect your investment to achieve returns of inflation +6 % per year over the longer term although your money will be exposed to short-term market volatility – making it an unsuitable option in the short term. If, however, you intend to use the money to put down a deposit on a home in approximately three years’ time, exposing your money to a combination of lower-risk assets such as bonds and cash would be a more effective strategy. Remember, while cash never produces negative returns, bonds, equities and property can and do, which makes knowing your investment horizon an imperative. 

Is there a chance you may need the money beforehand?

While you may have a specific purpose in mind for your money, be absolutely sure that you may not need to access the funds sooner than intended because this can affect the value of your portfolio if you need to withdraw at an inopportune time. Also, beware of earmarking your money for multiple purposes which require diverse investment strategies. For instance, if you are putting money into a tax-free savings account for your child’s education, withdrawing funds early to pay for your overseas travel will interrupt the process of compounding while at the same time adversely affect your R500 000 lifetime contribution towards a TFSA which limits your ability to save tax-free in the future. 

How accessible is my money?

There are significant tax advantages to be gained by investing in a retirement annuity structure, but it is important to know that you cannot access the funds held in an RA before age 55. As a means of forced retirement savings, RAs are therefore highly effective, although it is sometimes not advisable to put all your savings into a compulsory structure. With no access to capital before the age of 55, you may want to consider finding a balance between investing towards a RA to secure your retirement future, while also having a discretionary investment portfolio to provide for potential cashflow and/or capital requirements in the short to medium term. While financially it makes sense to maximise the full 27.5% of pensionable income that you can invest on a tax-deductible basis, it is important to balance this with your need to live comfortably in the present. 

Have you made use of all your available tax deductions?

As mentioned above, the maths says that one should first use the available tax incentives when it comes to investing, specifically when it comes to contributing towards an approved retirement fund and tax-free savings vehicles. We all know that retirement funds offer the most in terms of tax efficiency, not only because investors can effectively invest with before-tax money, but also because no CGT, dividends withholding tax or income tax is payable on investment growth achieved in the fund. Because most people need to save towards their retirement, it, therefore, makes sense to use as much of your tax-deductible premiums as possible – bearing in mind that very few investors are in a financial position to use the full 27.5% per year. Tax-free savings vehicles are not quite as tax-efficient as retirement funds, although they offer more investment flexibility and accessibility. While contributions towards a TFSA are not tax-deductible, all interest and dividends generated in the vehicle are tax-free, and no CGT is paid on withdrawal, which means that your return potential in a TFSA is higher than in a standard unit trust.  

What are the tax implications should you make a withdrawal?

Investments are taxed in different ways depending on the nature of the investment vehicle, so it is important to understand what tax you will be liable for if and when you make a withdrawal from the investment. For instance, if you commute a lump sum when retiring from your RA, you will be taxed according to the retirement tax tables with the first R500 000 being tax-free, although this will depend on whether you have made any previous withdrawals from an approved retirement fund. On the other hand, when making a withdrawal from a unit trust portfolio, you will potentially be liable for, CGT and dividends withholding tax depending on the structure of your portfolio and how much you have already withdrawn in the tax year. Local and foreign interest earned in your unit trust portfolio will be taxed at your marginal tax rate, while both local and foreign dividends are subject to dividends withholding tax (DWT) of 20%. If you are under the age of 65, up to R23 800 of local interest is tax-exempt, while for over 65s up to R34 500 is tax-exempt. Further, when you switch between unit trusts or withdraw, you effectively trigger a capital gain or loss, and 40% of your capital gain will be taxed at your marginal tax rate with the first R40 000 per tax year being tax-exempt.

What is your propensity for investment risk?

Everyone’s capacity for investment risk is different, so it’s important to gauge the level of risk you are most comfortable with as investing in a strategy that is too risky – or not aggressive enough – for your financial personality can ultimately lead to you abandoning your investment strategy out of frustration. For instance, if your investment portfolio is too aggressive for what you can reasonably stomach, this can lead to unnecessary stress and fear, causing you to cash in your investment at a loss. On the other hand, an investment strategy that is too conservative can lead to frustration and rash decision-making. Your propensity for investment risk is not the only factor that should be taken into account when choosing an investment strategy, but rather an important gauge to determine whether the chosen strategy will enable you to meet your lifestyle objectives.

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Craig Torr

Crue Invest (Pty) Ltd

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