Please advise on a better investment vehicle for R500 000 in a money market. I will not need it for at least five years. I am 38 years old, married and aiming to retire at age 55.
I have the following:
- Four bonds (one paid off, three for rentals);
- A tax-free account;
- R80 000 matured endowment policy (can be cashed out for an emergency);
- Three kids (eight months, four years old and eight years old);
- R80 00 online share trading portfolio; and
- A retirement annuity (R6 000 monthly contribution).
Well done on considering putting your cash to work in a better investment option than a money market fund which is likely to be yielding a negative real return (return net of inflation) after tax.
It’s important to note that every investor should have a financial plan which considers their overall financial context, their goals and objectives, and how they will ultimately achieve those goals and objectives. A financial plan can be half a page or it can be 20 pages long with carefully considered cash flow planning, tax considerations and various scenarios which can play out over time. I would encourage you to start a financial plan with the help of an independent holistic financial planner.
Although a tax-free savings account is limited to an annual contribution of R36 000, it’s a fantastic investment vehicle that should be utilised each year. It offers flexibility to invest in any asset class both locally and offshore.
Based on the fact that you have three rental properties, it’s important to have an emergency fund should you be required to pay for unexpected maintenance to the properties or cover the bond repayments in the event of rental vacancies. Your endowment policy serves as your emergency fund.
The dilemma as to whether one should pay off one’s bond(s) or contribute the capital to an investment is dependent on several factors such as interest rates and the value of the bond(s). South Africa is in a low-interest-rate environment which allows you the option of considering investing the capital as opposed to paying down your bond(s).
The graph below shows how low the South African interest rate is compared with where it has been in the past.
Offshore vs local investment
One could reason that you have three substantial future assets by way of investment properties as well as your primary residence, which are valued in rands and will receive rental income in rands. One could argue that these assets are also susceptible to South African centric risk factors. It therefore stands to reason that you may want to consider investing the R500 000 directly offshore in order to enhance the diversification and risk mitigation of your overall investment portfolio.
There are many views around what the optimal offshore exposure should be for a South African investor. The answer can understandably be different from one individual to another. The efficient frontier graph shown below suggests that based on the data since 1950, a 30% offshore exposure can help to reduce long-term risk while increasing long-term return.
Relative to the 30% foreign exposure mark, the purple dot shows that further offshore exposure can continue to reduce the risk and increase the return of a portfolio. The blue dot shows the point at which even more offshore exposure can yield the same risk at a higher return than the 30% exposure mark.
A Ninety One article by Paul Hutchinson entitled ‘How to invest offshore’ discusses the Regulation 28 conundrum. The chart below suggests that an investor who is looking for a high return over a three-year investment horizon requires a higher exposure to offshore assets. This is not dissimilar to the efficient frontier graph.
According to Hutchinson: “Therefore, a Regulation 28-compliant multi-asset high-equity or another domestic fund that is limited to 30% offshore exposure, may not be the most efficient solution. In fact, an unconstrained investment mandate improves the return characteristics of a multi-asset (balanced) portfolio at only marginally higher risk.”
The disadvantage of increasing one’s offshore exposure beyond the 30% mark is that it can add to an increase in volatility as a result of the fluctuations in the rand. This may be an issue for investors who have a more conservative risk profile and who require a high degree of income in local currency.
In conclusion, you may want to consider investing the money offshore as a diversification and risk mitigation measure. Depending on your risk tolerance, you could consider a portfolio of foreign multi-asset unit trusts through which you could gain exposure to equities, bonds/credit, property and commodities, with the fund manager making the appropriate asset-class allocation calls.