CAPE TOWN – In this advice column Beata Carstens from Veritas Wealth answers a question from a reader who wants help with choosing products for his tax-free savings account.
Q: I opened a tax-free savings account last year and am investing the full allowed R2 500 per month. I am 28 years old and this forms part of my retirement planning. Of the monthly contribution, 20% goes to a Swix index tracker fund, 30% to a Divi index tracker fund and 50% to a listed property index tracker fund.
As you can imagine, the investment has performed poorly up to now. I am getting a little concerned that the funds I am investing in might not be the best choice in today’s market. What is your opinion on these funds today? Do you think I missed the boat on listed property? Is investing in Divi and Swix tracker funds still a good idea or should I rather look at a balanced fund or an international fund?
I don’t plan to move any of the money I have invested in the current products. I am just re-evaluating the investment of my monthly contributions going forward. I don’t want to overreact or make emotional decisions about this, but I also don’t want to ignore the fact that the investment environment has changed since last year.
I would like to congratulate you on your decision to use your tax-free savings account as part of your retirement planning. The biggest saving the tax fee savings account offers an individual is that you pay no capital gains tax when you withdraw money, and having a tax-free income can have a big impact in your retirement years.
The R500 000 that you are currently allowed to invest in a tax-free savings account during your lifetime is equal to investing R30 000 a year for 16 years and 8 months. The good news in your case is that if you plan to retire at age 65, your annual allowance will be invested for just more than 22 years before you start using it. That means it will be compounding during that time, and you will not have to pay any tax on the gains.
In order to maximise your return on your investment over time, however, you need a clear investment strategy to guide your decisions over time. You appear to appreciate this, as you mentioned that you do not want to make emotional decisions about your underlying investment funds.
You also realise that the investment environment has changed since last year. But if we assume that your investment period is nearly 40 years, we would expect things to change regularly over this time.
As a start, you need to write down your profit objective for your investment. You can then design an investment strategy that will give you the best chance of meeting this goal.
I cannot advise you exactly which funds to invest in, but I can give you some things to think about.
Your time horizon allows you the luxury to invest in more aggressive asset classes such as equities and listed property. Investing in these growth assets over a period of time gives you a high degree of certainty that you will beat inflation on average by 7% per annum. If you can handle volatility in the markets, then you can set that as your objective.
The next step is to design your investment strategy to be robust enough to cater for different market conditions. That means being exposed to different drivers of returns.
For example, the Divi index is essentially a value index and will perform well when that ‘style’ is being rewarded by the market. It however will also go through times when it under-performs, such as it did last year.
Similarly, there will be periods when local equity performs well, and other times when international equities deliver better returns. It is worth considering whether you should be always exposed to both, or if you can make informed decisions about when to direct your contributions to one or the other.
An important decision you need to make in this regard is whether you have sufficient knowledge of the markets to handle investments during different market cycles or whether you are prepared to pay a fee for a professional to handle your investments for you.
While crafting this investment strategy is vital, just as important is having the discipline to stick to it. You should also have a system in place for measuring the effectiveness of your investment strategy over time.
Just bear in mind that great tactics may win battles, but well thought out investment strategies win wars.
Beata Carstens CFP ® is the head of the Veritas Wealth Paarl office.
If you have any questions you would like answered by financial planning experts, please send them to firstname.lastname@example.org.