With regards to the article ‘Investments: Beware of the cost of conservatism’, have you included fixed deposits in your sector returns or is the money market a basic 30-day notice account?
I would also like to know whether a five-year RSA Retail Bond (currently 8.5%) or a 10-year SA Retail Bond (currently inflation plus 4%) would be a good investment (and which investment would be better) and how conservative would it be considered? Should it be included as part of my retirement portfolio? I am 35 years old.
Thank you for your question.
The money market account I referred to in the above article refers to either money market accounts with banks or unit trust money market funds where current yields are around 4.4% with no fixed term. These funds or accounts are linked to the repo rate and follow the upward and downward movements of the repo rate. Money market accounts with banks have a varying rate of return dependent on the amount invested, whereas unit trust-based money market funds have a fixed unit price irrespective of the amount you invest.
I did not include fixed deposits because their returns vary widely based on the term and by the institution.
As a long-term investment, cash in any form is not ideal, especially if you are younger than 65, due to the taxation on interest earned.
The only time that cash in the form of a money market or fixed deposit account makes sense is when the investor is tax-exempt or where you are saving funds to spend on something over the next two years.
Where funds are invested in a special trust for a minor child or a special needs person or an NGO, interest-bearing investments can be justified since no tax applies in these structures. These types of investments are often set as the prescribed investment of choice in the trust deeds of such vehicles.
Once you consider investment periods of more than five years you enter the ‘growth’ space of the investment environment.
In my opinion, a 35-year-old who has 20-plus years left to retirement should be focusing on high-growth assets like equities and commercial property, and healthy offshore exposure.
Retail bonds are good solutions for retired individuals who need the income and who receive additional tax rebates. Retail bonds are taxed exactly the same as cash and fixed deposits. I would be hesitant to invest in a fixed five-year retail bond under current conditions. The repo rate was recently increased by 0.25% and is bound to move upward for the foreseeable future, which makes the 8% retail bond unattractive.
Interest rates can quite easily move close to and beyond a prime rate of 10% over the next two to three years depending on inflation. The inflation linker keeps you ahead of inflation but the margin reduces depending on your tax rate. If your tax rate is 30% the return of inflation + 4% retail bond suddenly reduces to 6.3% in total if inflation is at 5% (5% + 4% = 9% – 30% tax rate = 6.3%).
As far as a 10-year retail bond at 8% goes, the same applies. Your return will be reduced to 5.6% if you are taxed at 30%. The only difference is now you are locked in for 10 years during an interest rate cycle that is bound to increase to normal levels. Remember, pre-Covid the average money market rate was close to 10% per year.
Retail bonds make sense when you are in retirement. The fact that they are guaranteed by the government makes them a safe investment with a decent yield (tax depending). I would not, however, suggest investing in retail bonds as a mechanism for future retirement provision.
Given your age and depending on your investment horizon, you should be aiming at returns above inflation + 6% net (after-tax) as an investment objective for retirement provisioning. No cash or interest-bearing investment is going to provide that consistently after tax.
If you are very conservative and cautious of growth funds then rather look at income funds and low-equity multi-asset funds. Read the article ‘Investments: Beware of the cost of conservatism‘ that you referred to again and consider why it is so important to have a healthy chunk of exposure to growth assets locally and offshore while you are investing for retirement.
The lower your return the more you have to invest to achieve your retirement goal.
Example: If you need R125 000 per month in 25 years’ time (the equivalent of around R37 000 today at 5% inflation), you will need approximately R37 million in 25 years’ time. Assuming at age 35 you have R1.5 million (the target where you should be at age 35 if you earn R37 000 per month and you want to retire at age 60) thus far and you plan to retire at age 60 then the following monthly contribution will be required to reach your goal:
- Current provision future value at 8% return = R10.2 million (shortfall = R26.8 million)
- Current provision future value at 12% return = R25.5 million (shortfall = R11.5 million)
To fund the shortfall the following contributions will be required:
- If you achieve a return of 8% per year = R16 400 per month required.
- If you achieve 12% per year = R9 500 per month required.
The figures speak for themselves. However, don’t get flustered by the figures. In reality, you will start contributing at a lower level and increase contributions as your income increases. I used a level contribution calculation just to drive the point home of the importance of decent returns and what the implications are for being too conservative.