Monthly Archives: November 2016

What it means for your financial plan

Traditionally, the focus of every financial plan was retirement. Everything was built around the day that you have to leave formal employment at the age of 60 or 65.

However, more and more people are having to ask what happens next. In a time when life expectancy is steadily increasing, the idea of throwing away your briefcase and putting your feet up to live out your ‘golden years’ in peace and quiet is looking increasingly less appealing, and less practical.

For a start, there is little point in retiring ‘to do nothing’. Many retirees find that they are actually busier than they were during the working lives, but the difference is that they can do what they enjoy.

“We are finding more and more people who are re-thinking retirement,” says Kirsty Scully from CoreWealth Managers. “In most cases, they have been professionals in their careers and they want to stay employed to continue with their personal and professional growth and development, yet they don’t want a typical work schedule. They are looking for flexible working arrangements so as to have a good balance between work and leisure.”

Wouter Dalhouzie from Verso Wealth says that from both a mental and physical well-being point of view, it is important for retirees to keep themselves occupied.

“I had a client whose health started failing shortly after retirement,” he says. “He started a little side-line business and his health immediately improved. When he retired from doing that, his health went downhill and he passed away within a matter of months.”

Verso Wealth’s Allison Harrison adds that she recently attended a presentation that discussed how important it is for people to remain active. “The speaker explained that if we don’t continue using our faculties, we lose them as part of the normal ageing process,” Harrison says. “The expression she used was ‘use it, or lose it’!”

She relates the story of a retiree who had been in construction his entire working life.

“After a year in retirement, he decided to buy a second home, renovate it and sell it,” Harrison says. “This was very successful, so he decided to repeat the exercise using his primary residence.  This yielded a bigger return than the first one and thereafter then moved from house to house, renovating, selling and moving on.”

This way he ended up making more money in his 20 years of retirement then he did in his 40 year building career.

 

More competent than my white counterpart

Luthuli Capital was founded and structured as a Pan-African multi specialist company that offers a global approach to wealth management portfolios. The company offers investment advisory services to local and foreign individuals and multinationals, among others. I’m joined in the studio by one of the co-founders, Mduduzi Luthuli. Thank you so much for your time.

MDUDUZI LUTHULI:  Thank you for the invitation. Glad to be here.

NASTASSIA ARENDSE:  Let’s take it back to the beginning and start off with how Luthuli Capital came together.

MDUDUZI LUTHULI:  I think if you are going to start a company it’s always something that’s there. It’s just a matter of acquiring the skills for you to be confident to run the company and wait for the circumstances to be there.

I’ve been in the corporate sector now – from banking into the financial advisory industry – for about seven years. My previous employer gave me a great opportunity in management and it’s really there where I got to cut my teeth and get to the point where I realised I think it’s time for me to go out there and do this on my own.

We’ve got two offices here in Sandton and one in Durban. It really was the Durban office that was also the big motivator because we’ve got a project going on down there which involves the internship, and that also just got to that point where, if ever you are going to do this, this is the time.

NASTASSIA ARENDSE:  And I know that you work with Trudy as well. How did the two of you decide that it’s our synergies and both our characteristics and everything we’ve learned from our own sort of corporate size that can work together – and let’s do this?

MDUDUZI LUTHULI:  We both come from the same industry. So from a product knowledge side, services, the competency was there. I think really where the synergy comes from is they say I’m the driving force, I’m the bully, I’m the hard-core one. My real talent is bringing the clients into the business, going out there and selling the dream and convincing them that this is something you should back.

And Trudy, as head of client services, is the mother of the business, if I can put it that way. And really her strength is in client retention. You play a fine balance between finding new clients and also looking after your existing clients. And that’s really where we work with each other’s strengths and work very well together, because she heads up the client retention. I bring them and she looks after them.

The difficulty in determining cost effectiveness

Determining what added value you get when you pay above-benchmark investment fees for your collective investment scheme is similar to weighing the cost-effectiveness of a luxury German sedan against a Korean family car.

Will you get enough additional value from the investment to compensate you for the extra money you have to pay? Put simply, will you get bang for your buck?

If a fund delivers a 100% return during a particular year, an investor will probably have no problem sacrificing 10% of the return in fees. But if the return was 11%, forfeiting 10 percentage points in costs would make no sense.

This is probably the most important point in evaluating the fees you pay for your collective investment, says Pankie Kellerman, chief executive officer of Gryphon Asset Management. It is not about the absolute quantum you pay, but about what you buy for it.

The impact of costs

Calculations compiled by Itransact suggest that if an amount of R100 000 was invested over 20 years at an investment return of 15% per annum (inflation is an assumed 6%) at a cost of 1%, the investor would lose 17% of his returns as a result of fees. If costs climb to 3%, the investor would sacrifice almost 42% of his returns.

Unfortunately, it is not always that easy to get a clear sense of what you pay and what it is you pay for, but the introduction of the Effective Annual Cost (EAC), a standard that outlines how retail product costs are disclosed to investors should make this easier.

Shaun Levitan, chief operating officer of liability-driven investment manager Colourfield, says the time spent looking around for a reduced cost is time worth allocating.

“I think that any purchase decision needs to consider costs, but there comes a point at which you get what you pay for.”

You don’t want to be in a situation where managers or providers are lowering their fees but in so doing are sacrificing on the quality of the offering, he says.

“There tends to be a focus by everyone on costs and [they do] not necessarily understand the value-add that a manager may provide. Just because someone is more expensive doesn’t mean that you are not getting value for what you pay and I think that is the difficulty.”

Costs over time

Despite increased competition and efforts by local regulators to lower costs over the last decade, particularly in the retirement industry, fees haven’t come down a significant degree.

Figures shared at a recent Absa Investment Conference, suggest that the median South African multi-asset fund had a total expense ratio (TER) of 1.62% in 2015, compared to 1.67% in 2007. The maximum charge in the same category increased from 3.35% in 2007 to 4.76% in 2015. The minimum fee reduced quite significantly however from 1.04% to 0.44%.

The reality of retirement

In this advice column Robin Gibson from Harvard House answers a question from a reader who only has ten years to save up for retirement.

Q: I am 56 years old, healthy, have a reasonable job and presume I can work for the next 10 years.

I have a home which is worth about R2.5 million, with a relatively small bond. However, apart from an annuity worth about R300 000 I have no other savings.

My youngest child is almost independent, and in a couple of months time I will be able to save R10 000 per month. This amount can increase to R20 000 in the next 18 months.

How should I invest this money and how much trouble am I in?

The really important question here is the last one. In our view, any investor currently requires approximately R1 million for every R4 200 of monthly income they want before tax and after costs.

This yield is specifically constructed to provide an escalating income that keeps up with inflation. We are aware that an investor can source a fixed yield that is higher, but that would mean that it doesn’t increase in the future and progressively becomes worth less.

This also assumes that your capital will be maintained and over occasional periods will grow faster than inflation. This is important, because if you don’t have to use up your capital, how long you live and how long you need an income for become inconsequential. You could live beyond 100 and still have a secure income.

This is obviously the optimum position.

The next important question is then what to invest in to give you the best chance of building a retirement pot. The table below will demonstrate a value in today’s money of what your savings could be worth in ten years’ time. This is based on 18 months of investing R10 000 and then 102 months of putting aside R20 000 per month.

When looking at this table you have to consider that there are two key drivers that affect the investment return.

The first is cost. It may seem intuitive but it is amazing how investors are so easily duped. Costs reduce returns, and the higher the costs, the bigger their impact.

Where investors are usually fooled is that they are led to believe that their provider is somehow 25% to 30% better than the rest over a longer period. We are not so sure anyone can consistently claim that. There are good value options out there, so be cost conscious.

The second consideration is your choice of asset class. Investors hate volatility, but growth assets come with volatility. As a result, most dilute their returns with stabilising asset classes that have no track record of beating inflation over longer periods.

If you want to achieve returns of well above inflation, you therefore have to be prepared to live with short-term volatility. That means investing in products that predominantly hold growth assets such as equity and listed property.

Finally, something the reader has not specified is their expectations in retirement. Probably the biggest hurdle we face with individuals about to retire, is that they want to continue their current lifestyle with very limited resources.

What is available out there that can serve this purpose

A lot of people who get a bonus or once off additional income for whatever reason, tend to ‘blow it’ as you have pointed out. It is therefore a very good idea to try to think of better things to do with the money. I would, however, suggest that you consider not only your immediate or short term needs but also the long term potential of any extra income you receive – no matter how small.

If you have a need for extra monthly income, which might be the case if you are currently using a credit card or overdraft because your expenses are close to or more than your current monthly income, then I support your idea of putting the money in a vehicle that will allow you to supplement your income for the next two years.

A two year term, however, is a very short time horizon for an investment and I assume you intend to be drawing the full amount over the two years. In other words, you will be left with nothing at the end.

If so, you will need access to the money and very little, if any, risk. With these constraints in mind, I would suggest either multi-asset income unit trusts – the top funds produce between 8% and 10% per annum historically – or a bank savings, call or money market account with cash immediately available. These bank accounts produce between 5.5% and 7.5% per annum, depending on the amount.

Let’s use an example and say the amount is R50 000. If you can achieve returns of 10% per annum for the next two years, this will produce an income of R2 307 per month for 24 months before being depleted. At 7% per annum, the monthly amount will be R2 194 per month, so there is only a small difference, which means it is probably not worth taking the extra risk.

The question is whether you actually need additional income or if you are just going to be spending it over 24 months instead of one month. If you don’t really have a requirement for the additional income, you may want to consider investing the amount for a longer term so that it can produce even more for you.

You could consider putting the money into a tax-free savings account or retirement annuity (RA). By contributing to an RA, you would be reducing your taxable income. This means you could get something more back from the South African Revenue Service next year, depending on what retirement contributions you are already making.

Let’s use the same R50 000 we used for the example above and assume that you are below the maximum deductible contributions to your retirement funding. This is currently 27.5% of your remuneration or taxable income, or R350 000 per annum, whichever is lower.

Let’s also assume that you are in a 36% tax bracket. If that is the case, you would get an additional R18 000 back from SARS or have to pay in R18 000 less for income tax when you submit your next return. In other words, you receive your R50 000 dividend, you invest it into an RA which results in you having an extra R18 000 next year, and the R50 000 also grows until you retire. You can only access the money in an RA once you turn 55.

The tax free savings account option wouldn’t allow you to deduct contributions for tax, but it also doesn’t tie the money up until retirement. Taking into account that growth and income in the investment is not taxed, you can benefit hugely if you think of it as an additional retirement savings plan.

Save for more money tips

In this advice column, Zipho Mnyande from Alexander Forbes answers questions from a reader who wants to save up to buy a second car.

Q: I would like to start saving for a second motor vehicle. My current car is paid off and still in very good condition, so I don’t think I will need to replace it within the next five years.

I would therefore like to save the money that I was paying towards my monthly instalments to eventually buy a second motor vehicle for cash. Therefore, my savings term would be at least five years.

I have a money market fund with Allan Gray at the moment, but I find it difficult not to use these savings for other larger expenses. I would therefore prefer to use something that does not allow immediate and easy access to my savings. What would be best for this purpose?

The first step one should take is to identify the investment objective. In this case that is a car, with an assumed cost of R300 000 at the end of a five-year term horizon. It is important to understand this time horizon as well as your appetite for risk to decide on the most suitable investment vehicle.

Some of the most popular after-tax investment vehicles include endowments, unit trusts and the tax free savings accounts. These vary in terms of accessibility and tax implications and we would need to know the clients full financial situation before recommending a suitable product.

For a client who wants to lock their investment for a five-year period, an endowment would be a vehicle to consider. We do, however, have to take into account their marginal tax rate when making this decision.

This is because endowments are taxed within the fund at a set rate of 30%. This benefits investors who have a marginal tax rate greater than that, but can be prejudicial if their tax rate is lower.

Because the money in an endowment is taxed within the fund, your withdrawals are tax free. In order to get this benefit, however, endowments have a minimum investment time horizon of five years. At that point the money can be accessed or the investor can choose to extend the policy term.

You would be able to choose different underlying investments within the endowment, and given your time horizon, a moderate-to-balanced portfolio will most likely be appropriate. It is, however, important to take your risk appetite into account.

To know whether this would really be the best option for you, however, it is important to get an understanding of the tax implications from your financial advisor.

Times you withdraw your retirement benefit

In this advice column Beata Carstens from Veritas Wealth answers a question from a reader who is thinking of withdrawing his pension.

Q: I am 39 years old and have worked for the public service for just over 11 years. I am considering resigning because I want to further my studies for the next three years.

My current retirement fund value is R947 113.

How much will they tax me if I take this out and how best can I invest it?

The short answer to your question is that you will be paying R191 820.51 tax on a retirement fund value of R947 113. In other words, 20.25% of your retirement benefit will be paid to the South African Revenue Service (Sars).

How this is calculated is that your capital will be taxed on a sliding scale. The first R25 000 is tax free, the next R635 000 will be taxed at 18% and the balance will be taxed at 27%. Although not relevant in this instance, any amount over R990 000 would be taxed at 36%.

However, you can avoid this tax entirely by transferring the benefit to a preservation fund. This is an option you should seriously consider.

A preservation fund works in the same way as a retirement fund, except that you don’t have to keep contributing to it. You will be able to make one withdrawal from this fund before your retirement date, but otherwise you won’t be able to access the money until you turn 55.

Once you retire from the fund, the first R500 000, less any amount you have already withdrawn, will be paid out tax free. At this point you can withdraw up to one third of the capital as a lump sum if you like, but the rest must be used to arrange a monthly income during retirement. You will be taxed on your monthly income according to Sars income tax tables.

Why this is particularly important is because if you withdraw your retirement capital now, the R500 000 tax-free benefit that you would receive when you actually retire will fall away. So you will be suffering a double tax penalty.

Apart from the tax you will have to pay now, you should also consider the important differences between putting the money into a preservation fund and taking it out to invest yourself.

  1. Income tax paid on your investment

In any retirement product, no annual taxes are paid on interest or dividends. When it comes to discretionary investments, however, the interest you receive on your investment during any tax year will be taxed and you will liable for dividend withholding tax. You will also pay capital gains tax should you withdraw money from your discretionary investment for any reason, including switching funds.

  1. Liquidity

If you withdraw the funds now and invest the after tax amount, you will have easy access to your money. However, if you transfer it to a preservation fund, you could only make one withdrawal from the fund before retirement.

  1. Underlying investment funds

The Pension Funds Act has prescribed limits for different asset classes which are the building blocks of the underlying investments funds. The purpose of the limits is to contain the investment risk of the underlying investment funds.

However, by doing this, the Act also limits the potential upside of your investment. A discretionary investment can be 100% invested in equities (shares) and also 100% offshore, whereas any investment that falls under the Pension Funds Act can have a maximum of 75% in equities and 25% offshore.

  1. Discipline

With  easy access to discretionary investments,  a lot of discipline is required not to use the funds unwisely, whereas the rules of the Pension Fund Act actually force you to leave the money intact for retirement.

Finally, my advice would be to consider the pension capital that you have accumulated over time as exactly that and to leave it in your retirement pot. Do not fund lifestyle costs with capital earmarked for retirement. It will take quite some time, effort and a considerable monthly premiums to replace the retirement capital you have built up over your working career.

Data burning a deeper hole in the pockets of South Africans

In the wake of the #DataMustFall campaign, it seems that the data revolution might have a valid and legitimate plea. The campaign founders made a presentation before the Parliamentary Communications and Postal Committee on September 21 on the costs of data in the country. According to the soon-to-be launched findings of the FinScope South Africa 2016 consumer survey, the results show that the average South African spends about 9% of their purse on airtime and data recharge, cellphone contracts, telephone lines and internet payments. The average person spends approximately R700 a month for communication-related expenses.

Parallel to the #DataMustFall campaign, which is gaining traction, is the #FeesMustFall (reloaded) campaign, which is also resurfacing in light of the announcement of an up to 8% fee increase made by the Higher Education Minister Blade Nzimande. While university students would like to see a 0% increase, universities are requesting increases to sustain operations and fund research.

Therefore, in light of these developments and expenses, how does the purse of the South African consumer fair? The preliminary results of the FinScope 2016 survey shows that South Africans spend R688 per month on average on education.

The FinScope findings further show that South Africa’s total personal monthly consumption (PMC) expenditure in 2016 is estimated at R220 billion (monthly). On a monthly basis, the average individual spent approximately R5 400 during the period of conducting the FinScope 2016 survey. The results show that the main components of expenditure are on food (21%), transport (11%), utilities (11%) and communication, which amount to 9% of the spending purse.

Overall, individuals’ spending on education is 6% of their purse (estimated monthly spend of R12.2 billion). Further demographic analysis of the data per race showed that black communities still bear the greatest brunt of the education costs. For the average black South African, education expenses constitute 7% of their purse – this is higher compared to other races for which the purse composition for coloured, Asian, Indian and whites are at an average of 4.3% of their purse.

Furthermore, as one analyses the data further, it shows that nearly 12 million black South Africans spend more than 10% of their purse on education-related expenses. This is further exacerbated when noting that the average income per month is R4 723, R6 294, R12 265 and R17 123 for black, coloured, Indian and white South Africans respectively. As such, the cost of education places a heavier burden on black South Africans.