I need objective advice. I have R300 000 I want to invest over a five-year period. I need good returns without taking too much risk and attracting too much tax. Which is the best option between investing in a unit trust or a fixed-deposit account? I want to use the money to buy a small farm.
The question is probably one that most investors ask themselves if they are saving for a deposit on a house, car or business venture with a short- to medium-term time frame. However there are a few points that need to be noted before an objective opinion can be given.
- A return over any time frame must be seen in light of the risk taken to achieve that return.
Over the short-term, a unit trust with a great manager may underperform its peers, because they took a lower degree of risk than their peers. Likewise a mediocre manager may outperform a great manager over the short term, because they took a high degree of risk in a high-risk environment. The notion of a high return with a low degree of risk over a five-year period is in itself a fallacy that needs to be properly explained to investors.
- Tax is an important aspect to consider when structuring an investment portfolio. However it must be seen in the context of what you would like to achieve.
An equity return is treated more favourably than a return from a fixed deposit, but the risk associated with the two is not comparable.
Unit trusts with a minimum time frame of five years are typically your multi-asset high equity funds (also referred to as balanced funds.)
The graph below is the range of returns from the Foord Balanced Fund as of the end of April 2018, over different rolling periods.
The worst return over any 12-month period is -16.8% with the best return being 61%.
Over a rolling five-year period the worst annualised return is 7.1%, while the best annualised return over that period is 27.8% with an average annualised return of 15%.
The Foord fund is a good example of a great manager that has fallen out of favour due to their short-term underperformance.
Had you invested in the fund five years ago, your annualised return to the end of April 2018 would have been 8.19% (excluding platform fees) according to data from MoneyMate. This represents a far lower return than the average expected return from the fund, which gives context to how difficult the environment has been for managers to deliver high returns with a low degree of risk.
There has also been a growing trend where investors have been derisking their investments due to uncertainty and poor returns. However this will come at a cost over the long term. Had you invested your capital five years ago in a unit trust with a balanced mandate you may in hindsight have probably preferred to use a fixed deposit rather than a unit trust.
Going forward, the majority of managers appear more optimistic about the potential return over the next five years than what investors have had to endure over the past five years.
For you to make an informed decision, you need to know the risk associated with the options that are available. A balanced fund is generally seen to have a minimum time frame of five years and may require a longer period. A balanced fund such as the one above represents one of the top managers with a good long-term track record. However, as you can see from the divergence of best- to worst-case returns, poor market conditions can adversely affect a manager’s ability to generate returns consistent with their risk budget. This requires the investor to know the full extent of the risk that they are taking, given any investment option that they are presented with.
A fixed deposit gives you a steady return that is a known quantity upon investing. The interest is however fully taxable at your marginal rate subject to the annual exclusion. This is not a bad option for a risk-averse investor and should be carefully considered if it is appropriate to the risk that you are prepared to take.
Objectively speaking you may want to consider the use of a multi-asset low-equity or medium-equity fund, which can give a better return than a fixed deposit over a five-year period without the risk that can be associated with a multi-asset high-equity or balanced fund. The return can also be more tax effective than that of a fixed deposit.
It is also important that our expectation of returns is aligned with that of the risk required to achieve the returns. Unfortunately investors place more emphasis on high returns rather than the possible losses. However, investors feel the pain of losses far more intensely than the pleasure of high returns.