At 77 years old with R5 million to invest, is it better to invest with African Bank as opposed to a share portfolio?
Thank you for this very important question.
As always when responding to these types of questions we must begin with the comment that all we know about you and your circumstances is that you are 77 years old and that you have investment capital of R5 million. Nothing further is known, such as whether you have any outstanding debts, what other assets you may have, or if you require this capital to provide you with a monthly stipend or if you would be happy to simply invest this capital and let it grow until it may/may not be required at some point in the future.
Another aspect that would require response if we were to provide you with in-depth investment advice, would be to determine the time period you would wish to have this capital invested for.
When providing investment advice, we cannot simply look to see if one investment is “better” than another – this approach is too simplistic, and should this approach be used we would often find that the investment selected does not serve the need of the most important party in the investment, you the investor.
The best way to respond to your question therefore would be to analyse the investments in terms of:
- The risk to the capital over time.
- Accessibility to capital during the envisaged investment period should you require accessibility to part or all of the capital invested.
- Tax implications of the investment types selected.
We have conducted a simple analysis of African Bank’s deposit rates online and have found that African Bank is advertising 11.11% interest over 60 months. No indication has been made if this is a nominal interest or effective interest rate. We will therefore assume this is an effective interest rate.
1. Risk to the capital over time:
African Bank deposit
There is not much risk in depositing the capital with a South African registered and licensed bank. The interest rate quoted will be what is earned, and the initial capital invested should by all accounts be secured.
Where Africa Bank is concerned, we may need to consider that it is a smaller bank and in its history, it has already been rescued once by the government. Not that we are predicting that a rescue of African Bank may be required again.
What needs to be taken into consideration is the fact that African Bank is a smaller bank in the South African banking industry and therefore the risk of default with African Bank may be higher than those of its larger rivals. Which might also explain why African Banks deposit rates are a little higher than its rivals.
As a comparison, we looked online at the interest rates advertised by First National Bank over a 60-month term and the result was an interest rate of 8% (again uncertain if this is an effective or nominal rate).
Therefore, simply explained, the higher the risk one takes the better the reward over time.
If one were to consider classic investment theory, one would determine that in general, a share portfolio is riskier than a bank deposit.
It is also safe to say that not all share portfolios are created equally.
In general, share portfolios perform in direct correlation to the talents of the portfolio manager and how they select the shares in the portfolio, how these shares are bought and sold and not to forget how much cash is held in the portfolio at any one time.
The general risk of a share portfolio is based on the theory that shares are traded on an open stock exchange where markets experience periods of volatility when share prices are traded at fluctuating prices, which can increase the probability of experiencing not only low returns on your portfolio but even losses on the capital invested initially.
Again, general investment theory also dictates that over longer investment term the risk experienced in investing in a share portfolio is rewarded to the level higher than a bank deposit.
One should also keep in mind that when one holds shares, there are two ways to achieve growth in the share portfolio. Firstly, there is the value of the share held, based on the price of the shares. If the share price goes up so does the value of your investment. Secondly, a listed share is a part-ownership of the underlying company and when the company has a profitable year, part of the profits are distributed to the shareholders in the form of dividends.
2. Accessibility to capital during the envisaged investment period should you require accessibility to part, or all of the capital invested.
In our research into the rates offered by either African Bank or First National Bank, I could not find if one could access part or any of the capital sum invested during the 60-month term.
In my experience banks tend to advertise their best rate based on the idea that the capital is going to remain invested for the full 60-month term.
Therefore, if you were to invest the full R5 million with African Bank you would need to consider that should you require access to part or all of this money during the five-year term in question, then in all probability the bank would charge you some form of penalty.
Whereas in a share portfolio access to some or all, of the capital is a matter of selling the shares held to the value of the capital you require out. Listed shares are traded daily on the stock exchange and this would mean that the capital value could be paid to you in your bank account within a few days.
However, one should consider that share trading is all about timing, so you should consider the fact that when you may require some or all of the capital value, it may not be the most opportune time to sell the shares and this may result in some losses to the capital value.
In conclusion therefore when dealing with a share portfolio and the withdrawal of capital from it, timing is always of utmost importance.
3. Tax implication of the investments selected
Let’s begin with the bank deposit as suggested with African Bank at a rate of 11.11% per annum.
A capital sum of R5 million would then yield an annual interest of R555,500 per year.
As you are over 70, the first R34,500 earned in interest is exempted from tax and thus you would be taxed on the remaining R521,000 earned as interest. The rate at which this R521,000 would be taxed would depend on your rate of tax.
As for the tax on the earnings of a share portfolio, this is where it gets a little complicated, as it all depends on how the share portfolio generates earnings for you.
If there is some cash held within the share portfolio, then the cash would earn interest and this would be taxable in a similar way to a bank deposit.
When the share portfolio earns dividends then this is taxed at a rate of 20% at the source so by the time the dividend is paid to shareholders it is tax-free.
Should you sell the shares held in a share portfolio, you should be aware that this would trigger a capital gains tax event. Capital gains tax can be a little confusing but essentially you would add up the capital gains and capital losses realised during the tax year and should the capital gains outweigh the losses then you would pay a maximum effective rate of 18% of the gain if you are taxed at the maximum rate of 45%. Also bear in mind that the first R40,000 in realised capital gain for the tax year would be exempted.
Therefore, in conclusion, and my advice:
We would recommend that you consult a reputable investment advisor who would be able to look at your personal financial circumstances in detail and provide the right advice for you.
Secondly, should this amount of R5 million be the total value of your investment portfolio I would then always remember the number 1 investment rule: never put all your eggs in one basket! Diversification is key, not only when considering a share portfolio, but one should also diversify across asset classes.
Consider splitting up the R5 million into cash holdings (such as bank deposits or money market funds), South African shares listed on the JSE (or a basket of unit trusts) and then perhaps give some thought to having some exposure to markets outside of South Africa where the capital is invested in a hard currency such as US dollars and where it is invested in a global investment portfolio.
Thank you for engaging with us. We hope this assists you in providing a solution to your investment portfolio planning requirements.