When it comes to saving and building wealth for retirement, is it essential initially to buy property? I live in Cape Town and earn R17 500 gross income a month, which is not enough to buy a property – or is it? I always feel panicked when I hear people say you should invest in property. I am doing my best to invest in a retirement annuity (RA). Please advise.
Investing in property versus prioritising an investment portfolio is always an interesting debate, with many different opinions. Your age, which may have an impact in the long run, was not mentioned in your question.
Investing early in a primary residence does have advantages, minimising expenses and debt at retirement, which should be a priority in your portfolio planning. While rental expenses tend to increase with inflation annually, in the longer term repayment on a bond will be more consistent in most cases (although this is dependent on interest rates) and you will have the option of earning a rental income from this property – supplementing your retirement income.
I consider the above as two different financial goals that should be planned for independently – owning a property and building a resilient investment portfolio can be seen as different assets in your portfolio. Investing in a primary residence will require an initial deposit. Saving a monthly amount in a voluntary investment can be used to make provision for this deposit.
When building your investment portfolio, I believe time in the market can be a lot more valuable than timing the market. “The big money is not in the buying or the selling, but in the waiting.” This is one of my favourite quotes by American investor and vice chairman of Berkshire Hathaway, Charlie Munger. I believe the most important component of any investment is time. By ensuring that we start early, the picture changes significantly in the long run – protecting yourself from the situation of having to play catch-up later in life. We need to save approximately 15% of our income over our working career to be able to retire with a replacement ratio of about 75% of our income at retirement. A problem arises for most people who only start investing in their 30s or 40s. The 15% rule will then not provide enough retirement capital.
The chart below illustrates the importance of time in the market. It shows how the final capital amount of a R10 000 investment is affected if the 10 to 50 best days of the FTSE/JSE All Share Index and the MSCI All Country World Index were missed out on in the last nine years.
Missing out on the 40 best days (less than 2% of the total period) of our local market would have resulted in a return of 0.55% per annum. If you missed out on only the 20 best days of the local market you would have outperformed average inflation for this period. However, a fully invested portfolio over this period would have resulted in a return of 13.17%. This again shows that it is not about timing the market, but time in the market.
It is important to understand that contributions to a retirement annuity are tax deductible up to a maximum of 27.5% of the higher of taxable income or remuneration, limited to R350 000 per tax year. Any excess contributions may be carried forward to be deducted in the following tax year. There will also be no tax on interest, rental income, dividends or capital gains earned, making this a tax-efficient investment in your portfolio. However, you can only access your money from age 55, limited to one-third taken as a cash withdrawal, subject to the retirement tax tables. The remainder is to be used to provide a monthly taxable income by means of a compulsory annuity.
A tax-free investment account, together with a retirement annuity, is a good solution to make additional provision of retirement capital. All interest, rental income, dividends and capital gains earned in the tax-free investment account are exempt from tax. Tax-free investments are, however, subject to certain limits. You may not contribute more than R33 000 per tax year or R500 000 over your entire lifetime. When reaching retirement, you can structure your retirement by making tax-free withdrawals from these funds. This investment product is a discretionary investment and does not need to comply with Regulation 28, giving you the opportunity to maximise your local and offshore equity exposure.
By using a retirement annuity and a tax-free investment early on in your lifetime, you can benefit from the various tax advantages as well as the invaluable benefit of the power of compounding. After all, the end goal at retirement is to have enough capital to provide a sufficient income to maintain your current and future lifestyle.