Great business idea

You have to give credit to the founders of South Africa’s first online investment advice portal, InvestOnline.co.za. Rod Lowe and Nick Brummer spent almost two years automating the advice process for clients who are interested in making a unit trust investment. It’s a great business idea that could provide them with a nice passive income. At the same time they could potentially provide a much needed low-cost service to online investors who have already decided to invest in unit trusts, but just need help deciding between hundreds of portfolios (a.k.a. funds) out there.

Low cost advice

Commission-remunerated financial planners usually charge between 1% and 5% up-front and between 0.5% and 1% per annum for advice. InvestOnline.co.za guides investors through the decision-making process at zero up-front costs – charging only an annual fee of 0.57%.

Simple site lay-out

I played around on the website and found it relatively easy to navigate and the technicalities of unit trusts well explained. Unfortunately, as is often the case, with simplification important intricacies are ignored – to the investor’s detriment.

What about taxation?

Because InvestOnline.co.za considers only unit trust products, clients are not informed about other options that could save them a significant amount of tax, for example retirement annuities and endowment policies (for high net worth clients). But even within the unit trust range no mention is made of tax-efficient options, for example funds composed of preferential shares or funds which perform similarly to cash but without the high income tax associated with large sums of interest income. While I appreciate that tax advice is complicated and difficult to automate, I expect an online advice portal to at least flag high-tax paying investors and recommend that they speak to the founders in person about tax-efficient investment options.

The limitations of a risk profiler

With the first test-run of the risk profiler, I answered the questions with myself in mind and was not surprised to see that I’m classified as an aggressive investor – spot on. But when I tried it again, simulating how my semi-retired mother would have answered the questions, I suddenly became concerned. I told the profiler that I’m 65 and absolutely do not want to lose capital, that I may need to draw an income from the product within three to five years and that I have never invested in shares and definitely would not be comfortable trying them now. The profiler told ‘my mother’ that she has a moderate risk profile and recommended a medley of balanced funds (which may all invest up to 75% in shares). This is the same person who phoned me after the 2008 market crash and asked if we shouldn’t perhaps cash in her unit trust, because she hears there’s trouble in the financial markets. (Fortunately, she was invested in a super low-risk protected equity unit trust and suffered only a very brief and minor capital loss). Imagine her reaction if she was invested in a mix of balanced funds at the end of 2008. Who at InvestOnline.co.za manages clients’ expectations and reminds them of their investment strategies when panic sets in?

A great initiative, but perhaps the owners should have spent just a little more time testing their advice process with real-life users before going live.

South Africans registered as provisional taxpayers need to make their second payment for this tax year no later than 26 February 2010. MoreThanMoney has created a spreadsheet to help you calculate which figures to fill in on your provisional tax form (IRP6).

What would you need before you can start using this calculator?

You will need your payslips, invoices, proof of business expenses, bank accounts and investment statements, details about medical expenses, a list of all your RA contributions, a list of all your donations to Section 18(A) charities, a log book for your business travel expenses, and details of capital gains transactions, where applicable.

If you are going to deduct medical expenses, retirement fund contributions and donations, you will also need a SARS 2009/2010 tax pocket guide which states the limits to these expenses that you are allowed to deduct for tax-purposes.

How does the calculator work?

Click on the Input sheet tab at the bottom of the spreadsheet and then complete all the fields in green. Take special care wherever the tool asks for allowable deductions. You may have to familiarise yourself with the SARS 2009/2010 tax pocket guide to determine how much you are allowed to deduct for medical expenses, retirement fund contributions and donations.

If you have sold any non-personal assets, e.g. your primary residence, investment property or other investments, you can calculate your capital gain by using another MoreThanMoney tool called Calculating the CGT for your IRP6 2009/10.

Once you’ve entered all the relevant information on this sheet, click on the Result tab at the bottom of the spreadsheet. If applicable, you may still need to enter the amount paid to SARS for the first half of the tax year, as well as any penalties imposed by SARS, before arriving at the final amount payable by 26 February 2010.

What do you need to watch out for when using the calculator?

This tool does not automatically limit your medical expenses, retirement fund contributions and donations to the maximum amounts that SARS will allow you do deduct. You need to find out which limits apply to you and adjust the amounts that you enter on the spreadsheet accordingly. Someone who takes care of a disabled person, for example, is allowed more medical deductions than an individual who is the sole beneficiary of his or her medical aid membership.

For whom does the calculator not cater?

To keep it simple, this tool assumes that you have no business losses which you need to/want to ring-fence, i.e. carry over to future tax years, and that your foreign interest and dividends are less than R3500. Oh, and it also assumes that you are single or married out of community of property and not a legal body like a trust or a close corporation.

Disclaimer

MoreThanMoney unfortunately cannot take into account every taxpayer’s unique situation and can therefore not take responsibility for tax issues not covered by the calculator. MoreThanMoney does not take any responsibility for losses suffered due to the use of its calculators.

Does it sometimes feel like you’ve earned less on your investment than the figures quoted by the insurer or the investment company? Chances are good that – from your viewpoint and using the calculation methodology that you’re familiar with – you did actually earn a different rate from the published return.

Are the investment companies cheating? No. In more mature industries (like ours) performance reporting is standardised and well audited. But in order to publish standardised figures, they can’t reflect the idiosyncrasies due to the fact that investors:

• time their contributions and withdrawals diffrently;
• negotiate different types of intermediary fees with their planners.

And that makes all the difference.

When they publish a 5-year return, for example, they’re assuming you invested a lump sum on the first day of the period they’re measuring, that you remained fully invested over the five years, and that you didn’t sign a debit order or added to your investment on an ad hoc basis. Also, they look at the incoming investment money from their viewpoint. In other words, if you invested R100 000, of which R2 000 was commission, you’ve only invested R98 000 on their books.

More relevant to you, and also the more accurate measure – catering for every investor’s unique scenario – is the actual annualised return a.k.a. the internal rate of return (IRR) on your cash flows. This methodology looks at all your cashflows and then determines what annualised effective interest rate a zero-cost bank account had to pay on your contributions to leave you with the same investment balance as the insurer or investment company’s pay-out at the end of your investment term.

Want to calculate the IRR on your investment but don’t know how? Don’t worry, our What Did I Actually Earn? calculator will do it for you.

Interest rates are low by South African standards, and investors with spare capital or borrowing power may be tempted to dive straight into the buy-to-let property market. Because you can’t go wrong with property, right?

It is to test sweeping statements like the above, that we’ve designed the Return on Property calculator to work out the expected long-term returns on your investment under different assumptions. This tool allows you to choose the bond rate, increase in rental income, increase in property maintenance costs and capital growth on your property that you think is realistic.

If you need help to complete the second input field of the calculator, relating to transfer and bond registration fees, you can download the The Real Price of a Property tool for a good estimate of up-front costs.

Just remember that the Return on Property calculator does not account for your unique tax situation.

Happy investing.

When I just started working, I was amazed at how so many of my colleagues could bend their knees under the weight of a boulder of a bond just to own a home. The few of us who rented definitely had more spare cash to enjoy every month. Until someone pointed out (what should have been obvious) to me what happens to your rent at the start of every year and continues to do so for the rest of your life, while your home loan instalment stays fairly stable for 20 years and then disappears.

Our Renting or Buying a Home calculator illustrates this point. Yes, we’re not comparing apples with apples here, as rent is an expense with no reward other than a roof over your head for a month, while your bond repayment is an expense linked to the reward of owning a property somewhere in the future. But the calculator can show you instantly:

• how your rent will increase over the years
• the instalment on a bond amount that’s appropriate to your level of income
• the up-front costs associated with a property purchase

(If you don’t want to purchase such an expensive property as the amount for which the calculator shows your income may qualify, our The real price of property calculator allows you to enter your own amounts for the price of the property and the amount of the bond that needs to be registered.)

Many disciplined investors don’t buy the ‘as safe as houses’ investment adage, though. They prefer to rent for the rest of their lives (or until they have saved up a large enough deposit) and invest the amount by which a bond instalment exceeds the rent that they are paying.

If you download the Renting or Buying a Home calculator, you’ll see it will take approximately 12 years before inflation causes rent of R4 000 per month to catch up with a bond instalment on that same property worth, say, R940 000 (Cape Town prices). That’s assuming that the bond applicant earned R30 000 p.m. to qualify for a 100% home loan at the bond rate of 10%, and that rent increases by 7% per year.

In the scenario above, the tenant investor will therefore have excess money to invest over 12 years. By ‘excess’ we mean the difference between what her bond repayments would have been and the rent she actually paid. If she invested all the money that she saved by not buying a property, including the up-front costs related to the property transfer and bond registration, and that investment yielded 11% per year after tax, she can expect her investment amount to be worth more than R1.1 million after 12 years.

But there are other expenses which the calculator does not show. Tenants normally do not have to pay maintenance and rates and taxes, which could be substantial. Let’s assume these additional ‘homeowner costs’ start at R20 000 per year and increase by inflation of 6% per year. Because our disciplined tenant investor did not have these expenses, she could have invested these amounts in the same place where she earned 11% per year after tax, and these accumulated amounts would have been worth approximately R600 000 after 12 years. That leaves her with a total investment lump sum of about R1.7 million after 12 years of renting and diligently investing all the money that she saved by not having to pay bond instalments, the up-front fees of a property purchase, rates and taxes or maintenance.

It may look as if tenants have a point – until you look at what a home owner’s property may be worth after 12 years. If we assume that the capital value of property grows at 7% per year, the R940 000 property should be worth just over R2.1 million after 12 years.

This is a very specific scenario, and by changing a few assumptions or by choosing a very specific investment term, we could make either the tenant or the homeowner look like the cleverer of the two. The important points to remember are:

• Think long-term when you make a financial decision.
• Understand all the risks and future expenses associated with your decision.
• Don’t underestimate the power of either inflation or compounded investment returns.
• Be careful of sweeping statement. Do the calculations.

  

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Last year almost one million taxpayers did not submit a tax return because they earned less than R120 000 during the year. While many of these employees rightly rejoiced in the fact that they may stay below SARS’s radar, others sadly missed out on a welcome cash-back from the taxman. How can this be?

Employees who earn less than R120 000 per year, have a single employer, pay PAYE and have no additional income or deductions other than those on their tax certificates, do not have to submit a return. Unfortunately, many taxpayers are not aware that they have tax-deductible expenses that do not appear on their certificates. By not filing a return, they never inform SARS of the additional deductions and miss their refund. Their employers, unknowingly, have paid more tax on the employees’ behalf than was necessary.

There are many deductions that are outside the employer’s field of vision, but the most relevant ones are private retirement fund contributions, donations and medical expenses.

If the employer is unaware that the employee is contributing to his own retirement annuity (RA), for example, the deductible portion of the RA premium would not appear on the employer’s tax certificate. The deductible amount varies, depending on the size of the employeeís salary, and whether he’s also contributing to an employer fund, but the employee should be able to deduct at least R1 750 of his RA premium from his taxable income.

Donations to public benefit organisations (section 18A) can also be deducted, up to an annual limit. Many schools and churches are registered as section 18A organisations – you may be surprised at how the taxman rewards your generosity towards these institutions.

Wishing you something back at the end of this filing season!

I don’t know a single person who doesn’t enjoy getting something back from the taxman at the end of the year. But some prefer to stay as far below the taxman’s radar as possible – by not registering as tax payers or by not submitting a tax return. If you are one of these, you could be shooting yourself in the foot and robbing your own household of extra cash in the bank. Let’s look at a few scenarios where registering as a taxpayer or submitting a tax return could benefit either the household and/or the taxpayer.

In the first scenario a spouse is employed by the husband or wife’s business. The husband may be officially retired according to SARS’s records, but in reality receiving a salary – off the record – from the cash earnings of his wife’s business for administrating or supervising part of the business. The husband doesn’t want the hassle of submitting a tax return every year and has convinced his wife, the owner of the business, to not disclose his salary to SARS. Other than the fact that the non-disclosure of income is an illegal action, the husband could also be robbing his own household of after-tax earnings. In which circumstances would this be the case?

If the husband’s salary is disclosed in the business’s books, the business would be entitled to deduct that salary from its income, which results in a lower taxable income and less tax payable by the business every year. Even if the employee spouse now has to pay tax, that amount would be exceeded by the tax saving of the employer spouse in all circumstances where the employee spouse’s tax rate is lower than the employer spouse’s tax rate. The household (the employer and employee as a combined entity) will therefore be left with more after-tax income by disclosing the salary.

There are a few administrative hassles, though. In the scenario above, the wife would have to register with Revenue as the employer of the husband and contribute 1% of his salary to UIF every month and the husband will also sacrifice 1% of his salary (capped at R125 per month) to UIF. If the salary exceeds the 2009/2010 tax thresholds (R54 200 for persons under the age of 65 and R84 200 for those above 65) the wife would also have to deduct PAYE and/or SITE from the salary. If the husband earns less than these thresholds, he would not have to be registered as a taxpayer with SARS, but the business still enjoys the tax relief of deducting his salary from its taxable income.

To prevent businesses from abusing the potential tax relief associated with employing spouses, the Income Tax Act stipulates that only the payment for services by a spouse that truly contributes to the trading income of the business may be deducted as business expenses. The Act also specifically prohibits the deduction of any domestic or private expenses. In the scenario above, it would therefore not be possible for the wife to deduct payment to the husband for moving the lawn of their private residence or for managing their household chores. Excessive salaries will also raise a flag with SARS. If you pay your spouse a salary that is higher than the going rate in the market for similar services, SARS may disallow that business deduction.

But if you are truly employed by the business and paid a market-related salary, disclosing your income could be a relatively easy and painless way to leave you, as a couple, with significantly more after-tax income at the end of the year.

On 31 August 2009 trading starts for the fifth Make a Million competition. Last year, instead of buying actual shares for their competition portfolios, entrants had to buy single stock futures (SSFs) for the first time – a slightly more complicated and riskier game.

Buying an SSF does not mean buying the share; it means buying exposure to the share price movement. Because you don’t have to deposit the full value of the shares you’re interested in, a little money can go a long way – or really burn you if the price moves in the opposite direction than you thought it would!

How does an SSF work? You normally deposit about 15% (called margin deposit) of the amount that the shares would have cost you, but enjoy full exposure to the share movement. For example, if the shares are worth R10 000 when you buy your SSF contract and the share price subsequently increases by 10% (R1 000), your 15% (R1 500) margin deposit will yield a R1 000 profit – a return of 67%. But if the share price falls by 15%, for example, you lose your entire margin deposit – a negative return of 100%. If you need more examples, have look at my previous blog on how an SSF works.

How does buying SSFs differ from building a long-term, traditional share portfolio? With an SSF account:

• You could lose more than your capital when the share price falls quite sharply. (You may want to set up a stop-loss with your position to prevent this from happening.)
• You could leverage your profits, as you need to deposit only a fraction of the value of the underlying shares.
• You are usually less concerned with the business fundamentals of a company, as you could have lost either your margin deposit or your patience long before you see the true value of the company reflected in its share price. SSFs are more suitable to share traders than long-term investors.
• It’s easier to short a share. (Shorting is selling a share that you don’t own with the idea of buying it later at a lower price and making a profit.) If you believe that the share price is going to fall, you can just instruct your broker that the SSF contract is a short position.
• You generally pay lower brokerage.

And how does playing the Make a Million competition differ from holding a normal SSF account with a broker? Well, in exchange for standing a chance to win that million, you need to put up with a few restrictions:

• You can only deposit R10 000 per competition entry, of which R9 000 is used as your margin deposit and the remaining R1 000 acts as an additional buffer which earns interest. Nothing stops you from opening several accounts, though.
• Unlike a normal SSF account, you cannot deposit extra funds into a Make a Million account. When you have lost your margin deposit due to the share price falling, you are out of the game.
• You cannot keep your position open after the last day of the competition. Before the close of trading on 13 November 2009, you need to have only cash and no more share exposure in your Make a Million account. With a normal SSF account you could continue your exposure for as long as you please and just roll the 3-month contract over from one quarter to the next.

SSFs are great instruments for those stock market players who want to gear up their capital seven-fold and don’t mind losing that capital when they make the wrong call.

In less than a year, South African banks have dropped their prime lending rate from 15.5% to 10.5%. Under normal circumstances, one could expect some exuberance among consumers, but not this time round. Business confidence is low and consumers have witnessed retrenchments, property and equity markets losing much of the value that they’ve built up over the past years, and credit becoming scarce almost overnight.

Businesses would love you to channel the extra money left in your pocket after the bond rate cuts towards their cash registers, but should you not rather channel it towards your own bond repayments? Conventional wisdom screams ‘yes’ to the latter. And if you use our Killing your bond calculator, you may be pleasantly surprised at how big a difference even an extra R1 000 per month could make to your remaining bond term. If, for example, you still owe R500 000 on your bond and need to pay the bank R5 400 every month, depositing an extra R1 000 with every payment should decrease your repayment term by six years.

But settling home loan debt first is not necessarily the right answer for everyone. Running into cash flow problems is the cause of many foolish financial decisions, like selling fixed assets at the worst time in the market or applying for personal loans at much higher interest rates than the average home loan rate. Therefore first set up your own emergency fund – a high interest earning money market account containing about three times your monthly cost of living – for those times when the going may get tough. Owners of business start-ups or businesses still struggling with their cash flow, may want to build up an even larger cash buffer.

There are also ways of spending your extra money that could provide you with a much higher return than the interest on your bond. Enrolling for a course that increases your annual earning potential is one example of such a high-return investment. It seems like the average MBA graduate, for example, can expect his or her tuition fees back in the first year after studying – in the form of a much higher salary.

But these higher-yield investments seldom guarantee their returns, while you can be pretty certain that putting extra money into your bond will decrease your repayment term and will have the same effect on your pocket as earning interest at your bond rate. Without having to pay tax on it.

What % of your gross income goes into your bond?
	more than 25%
	between 12 and 25%
	less than 12%
	I have no bond.
pollcode.com free polls

I’ve been uneasy ever since that phone call from an attorney claiming that I owe my previous gym a few thousand rand. It was easy to prove that it was an error and we quickly resolved the matter. But what else is lurking on my credit record that I’m oblivious to? Not knowing your credit status could waste precious time when your loan or new account application is rejected because of a poor payment history. It could take several months to clear your name.

Fortunately, there are no more excuses to be in the dark about your credit risk rating. It will take you a few minutes to register as a member on Experian’s www.creditexpert.co.za and after receiving your PIN via email, you can obtain your credit summary online for free. If you need a more comprehensive credit report, you simply fax them proof of identification, as well as proof of residential address. As a registered member, you are entitled to one free report per year.

What do you do if your record reveals long overdue debt? Firstly, if you’re in the wrong, settle it as soon as financially possible. If you believe there’s been a mistake, gather all documents that you believe will prove your innocence and contact your creditor.

While you’re busy clearing your name, you may want to lodge a dispute with Experian. It usually takes about 20 days to resolve a dispute and during this time credit providers would not be able to view the disputed item on your credit record.

Even if you have paid your dues, many companies will keep you blacklisted for a further few years, which could still make it difficult for you to obtain credit. Even when your loan application is successful, you could be paying a higher interest rate than other applicants. It is at times like these that the services of an attorney could come in handy to assist you in your application for a rescission (the removal of your name from the blacklist).

Hahn & Hahn, one of the firms specialising in blacklisting, also has a few tips on their website on how to avoid appearing on the list in the first place:

• Pay all your debts before the 7th day of each month.
• Notify all your creditors of a change of address.
• Attend to legal documents and letters immediately – they will not go away.
• Should you be unable to pay your debt, make suitable arrangements with your creditors and keep to your arrangements.
• Be very careful of what you sign.

One could also add to the list another tip from business coach Thayn Niemand: If a company offers you more credit than you need with them, don’t accept it without thinking of the implications. That higher credit limit reduces the amount of credit for which you qualify with a company offering the type of credit that you actually need.

Lastly, if you are still unhappy with the treatment that you are receiving because of your credit record, you can also call the Credit Information Ombud (CIO) on 0861 662 837.

It’s never been easier to find out what your credit record is telling other people about you. And it won’t cost you a cent. Go ahead and make sure that your name is clear.

Falling interest rates is one of the precious few things to smile about at the start of a recession. Banks have dropped their prime lending rate from 15.5% to 11% over the past six months. But governor Mboweni has signalled that this might be the last rate cut for a while. Should you fix your mortgage rate now before prime starts soaring again?

In South Africa, variable mortgage rates, expressed as prime minus a percentage negotiated between you and your bank, are the norm. But most banks also give you the option to fix your mortgage rate for a period of between one and 10 years. Unfortunately, you can potentially run into two problems when you fix that rate.

Firstly, you are bound not only to the rate that you’ve been offered, but also the term that you’ve chosen. Should you wish to get out of that 10-year fixed rate contract, for example, your bank could enforce a heavy penalty.

Secondly, the fixed rate offered is often not very attractive. It is driven by the expectations of traders in the fixed interest rate market. If you think you have a few good reasons to expect rising interest rates, the traders have probably priced in those same expectations. In these market circumstances, the result is a fixed interest rate which is higher than the current prime lending rate.

There are exceptions. John Loos, strategist at FNB Homeloans, recalls that FNB offered 13% to a fixed rate client in January this year, 200 basis points below prime at 15%. At that time the overwhelming consensus in the market was that a series of rate cuts is on its way, the majority of traders predicting it would be somewhere between 300 and 400 basis points. Will this client beat the average rate of the interest rate cycle over his selected term? Who knows? Like any gambling game, the winner ends with a distorted sense of his or her powers of prediction.

Rather than an instrument to try and beat the country’s average official interest rate over a selected term, the fixed interest rate was designed to provide mortgage owners with some certainty. It makes most sense for those who would not be able to afford their mortgage repayments when rates rise, and for those who sleep better when they know exactly what their repayments for the next few years will be. Like any insurance, though, the certainty comes at a cost: the premium that traders in the fixed interest market charge for exchanging the risk of the variable rate and providing you with the safety of the fixed rate.

When I was about five years old I got my first ‘grown up’ bike, a classic black broad-wheel pushbike. My dad told me that he intended to put side-wheels on it, but if I wanted he could hold it and I could give it a test run. ‘No thank you, no need to hold it,’ I told him. With my feet barely touching the pedals, let alone the ground, you can just picture how spectacular the fall was when I lost the less than two seconds of momentum that kept the bike upright. I waited for the side-wheels until I gave it another try. Some lessons are only learnt the hard way.

As you may have noticed, the US banking system is still taking the gravel and dirt out from under its skin after an earth-shattering fall – the greatest since the Great Depression. Some of the assets owned by US banks have dropped in value so rapidly that the market has frozen and it has become almost impossible to trade these ‘toxic’ assets. As a result, over the past year the market capitalization (number of shares in issue multiplied by the prevailing share price) of many banks has diminished three-, four- or even more than ten-fold, as is the case with the once mighty Citigroup and Barclays, for example.

But it is not only the shareholders of these financial companies that have seen their investment portfolios blasted to pieces. Ordinary citizens are suffering too. Because of their own precarious financial situation, banks are not parting with any comforting cash in the kitty right now, and have become extremely reluctant to lend to almost anyone other than those who barely need the loan. Not the kind of environment that enables entrepreneurs to start new businesses and existing businesses to expand. Economic growth and job creation has screeched to a halt.

Even more worrying, is the fact that the link between the government’s generosity towards the banks (in the form of bail-out plans and quantitative easing) and the banks opening their hands for potential borrowers, appears severed for the moment. Basic monetary policy (lowering interest rates and/or releasing more money to stimulate the system) is failing. And, unlike South Africa, the US has very little room for fiscal manoeuvring (using the national budget to invest in infrastructure or spending to stimulate the economy).

But the most disturbing is the latest plan by Geithner to effectively use tax-payers’ money to sponsor investors who are willing to take some toxic assets off the books of the largest banks. And who wouldn’t be willing if the terms are so enticing as to provide potential upside (growth in the value of the assets) with almost no downside (the US government and taxpayers will carry most of the burden if the toxic assets remain worthless)? No wonder some of the top executives of the banks have already indicated that they would be very interested in this investment opportunity in their personal capacities.

To put it bluntly, the caretakers of many US financial institutions have become spoilt brats. Not only is their sense of their own importance as inflated as their salaries (which in 2007 peaked at 181% of the average for all US domestic private industries), but they are also abusing the close political relationships between government and financial enterprise. For example, as former IMF economist Simon Johnson points out, Robert Rubin, once the co-chairman of Goldman Sachs was also the Treasury secretary under Clinton, and later became the chairman of Citigroup’s executive committee. Henry Paulson, the CEO of Goldman Sachs, was also the Treasury secretary under George W. Bush.

Expecting that their friends in government will always be there to bail them out, the upper echelons of the financial industry continue to borrow excessively, lend irresponsibly and invest in assets which they barely understand, but which satisfy their lust for continuously higher returns. But higher returns and above-average growth always comes at a price: risk. Risk is and remains the most misunderstood (and sometimes totally ignored) concept in the financial industry. When risk continually realises in your favour and you reap the higher returns, you start to believe that you’ve tamed the market. But the high-risk investment landscape is, by definition, always unpredictable and when you are surprised by the vicious, previously hibernating bear, only then do you know whether you are truly comfortable with that specific risk landscape. Unfortunately, the managers of these financial institutions did not venture into the wilderness alone; they also dragged shareholders, home owners and taxpayers along on the hunting trip.

In times like these the US government cannot afford to act like the indulgent grandparent, allowing its greedy child to run amok and create ruin without experiencing the consequences. Stronger interference, even up to the point of temporary nationalisation, is necessary. If the US financial system does not learn its lesson here and now, it may be taking even bigger risks as soon as it is back on its bike again.

Friday morning it happened again. A small commotion, police officers and fingerprint specialists arrive on the scene, and afterwards locks need to be replaced. Although I was lucky this time and found my car with the boot wide open, but still there, the neighbours were less fortunate and lost their car and other valuables. With the previous round of break-ins it was my turn.

Unlike love, very few would say that it’s better to have owned and lost than never to have owned at all. Losing jewellery or gifts that are irreplaceable and carry so much sentimental value always feels pretty senseless. How can you cushion yourself against the blow?

Keep your insurance up to date.

Do you have a household inventory? Check whether the contents cover of your insurance policy has kept up with your purchases. If, for example, the assessor values your household content at R100 000, but you are only covered for R50 000, you carry the excess amount plus 50% of the value of items stolen. If a claim of R10 000 is approved, the insurance company will pay only the 50% risk that it carried (R5 000) less the excess amount. Specifically mention personal purchases, like cameras and spectacles, in the ‘General all-risk’ section of your policy.

Make sure you can prove ownership.

Knowing insurance companies, you’ll probably end up with a ring from Sterns if you don’t have a photograph and the receipt of your Uwe Koetter wedding band. Preferably keep this evidence in a place where the burglars won’t be able to find them, for example on a secure website or as attachments in your Gmail account. Also, specify your jewellery in the ‘specified all-risk’ section of your policy.

Know your rights.

You can appeal when the insurance company does not accept your claim. It may be good to have a broker on your side if you want to win this battle.

Don’t attract attention.

This one I learned from my domestic. Draw the curtains when you’re not home or when you have the garden services/maintenance around the house. What people can’t see, they generally don’t know they want.

Invest in a home safe.

This has saved me plenty of tears with my last burglary. Make sure you bolt it into a corner of a room, where it is most difficult to use leverage to break it out of the wall again.

Despite all of these precautions, I sincerely hope you never need to claim again…

Life is too short for being little – Benjamin Disraeli

It’s a pity so many people confuse a simple life with a small life. A recession may be looming and worldwide consumers are tightening the belt, but you can simplify your finances without cramping your style:

Be more focused

Do you really want to start a new business, train for the Argus, write a book, learn to tango in Buenos Aires, climb Kilimanjaro, fly to India to find yourself, take French cooking lessons and qualify as a dive master all in one year? Sometimes really focusing on one aspiration at a time, with mindfulness and gratitude, can be the greatest experience of your life.

Determine which dreams and desires are yours

Is it really you wanting that 5-bedroom house with the swimming pool or are you perhaps trying too hard to fit in with colleagues and acquaintances?

Cut the clutter

Get rid of everything that doesn’t give you joy anymore, but requires maintenance, insurance and storage space. To allow new experiences into your life, you need to create the mental and physical space.

Examine your expenses

Which costs can you cut in half without feeling deprived? Love sushi? Use one of the several 50% off midweek-specials. Don’t have a time switch on your geyser yet? Using one, you can easily halve your electricity bill. Planning your annual holiday? Why not take a winter break this year and enjoy huge discounts on accommodation.

Use all the free stuff to enlarge your world

From Skype’s free instant messaging and telephone calls to Google’s free email and storage space, it’s never been cheaper to chat with friends from all over the world, or run a business from home.

Consolidate and simplify your debt

Not only will one loan repayment every month feel less overwhelming than settling several accounts, but it could also save you a small fortune in interest. Check which of your loans or accounts charges the lowest interest. (It’s very likely to be your home loan.) Then apply for just enough extra credit on that low-interest account to settle all the debt of your higher-interest accounts.

But most importantly, don’t let the recession mentality bully you into thinking small. Money has an uncanny way of following big plans, executed simply and elegantly.

On 3 November, when trading starts for the 2008 Make a Million competition, thousands of South Africans will experience first-hand how derivatives work. Unlike previous years, when entrants bought the actual share, they will now be buying single stock futures (SSFs) – a leveraged and slightly riskier game.

What is an SSF?

An SSF is a 3-month futures contract, of which the price is linked to the actual listed stock (aka share). When you enter the contract as a long position, you are betting that the share price will rise during the contract term; when you enter as a short, you are betting that the share price will fall. At the moment there are more than 250 SSFs available on the South African Futures Exchange.

How does it work? An example:

Say you want to buy 100 Anglo American ordinary shares, but don’t have the capital required. With SSFs you can get exposure to the share price movement over the next three months, but with less capital. This is how it works.

The pricing: If the Anglo American ordinary share (AGL) price was R300 today, you could expect the December 2008 futures contract to be priced around R31 000. That is because you have to buy SSFs in lots of a 100 each (R30 000 for a 100 of AGL) and the financing cost or interest is then added to this amount. If dividends are expected before the futures contract close-out date, the dividend amount is deducted to reach the AGL SSF price.

The margin deposit: You don’t have to provide R31 000 to buy the AGL SSF contract, though. You only put down the required margin, which depends on the volatility of the underlying share price and can be anything between 10% and 20%. Let’s say the margin for the AGL SSF at the start of the futures contract is R4 600. That’s all you need to give your broker when you buy the contract, which is exactly why you are paying a financing cost on the value of the underlying share. This is a geared investment (i.e. with borrowed money). Just keep in mind that, as far as price movements are concerned, you are exposed to a R30 000 asset. If it loses R3000 of its value, you carry the full R3 000 loss.

The contract period: There are four SSF contracts per year for each share. Your December AGL SSF contract will expire on the third Thursday of December, i.e. 18 December 2008. If you don’t sell your contract earlier, you will end up with any increase in the AGL share price (x100) in your cash account on that date.

Margin top-ups: In the mean time, until you sell the contract or it automatically expires, it could get tricky if the share price falls. Say the AGL price drops from R300 to R270 in one day. With your contract of 100 shares, this means you end the day with an unrealised loss of R3 000. The broker will automatically take R3 000 from your cash account to recover the loss. If you don’t have enough money in your cash account, you’ll have to deposit extra money with your broker.

How does buying SSFs differ from buying shares?

• You get more gearing. If you want to borrow money to buy a share, you usually have to provide at least 70% of the capital and a bank may lend you the other 30%; with a SSF you get exposure to the total movement in the share price with only a 10 to 20% margin deposit.
• You could lose more than your capital. If your margin deposit was only 10% and the share price falls by more than that before you get a chance to sell out of your position, you’ll have to pay in more money.
• It’s easier to short a share with an SSF. If you believe the share price is going to fall, you can just instruct your broker that the SSF contract is a short position.
• You generally pay lower brokerage on SSF transactions.
• Buying SSFs is not a buy-and-hold game. You need to watch the share price daily and decide whether it may be necessary to close out your position. Unlike shares, you can’t just sit out a large price decline until it recovers a few months or years later. With price volatility, your cash account could increase or decrease dramatically from day to day – or even turn negative.
• While you can either invest in shares or speculate on their short-term price movements, the 3-month contract term of an SSF is too short for fundamental investment principles. Unless it’s being used to hedge out short-term share price volatility, SSFs are traders’ instruments.

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The Make a Million competition

For competition entrants a few additional restrictions apply, e.g. the compulsory closing out of positions when you’ve lost more than half of your margin deposit. Visit www.makeamillion.co.za for more details.

If you’re an enthusiastic share investor, you’ve probably wondered about this one before. Should you outsource the stock selection to a portfolio manager or should you do it yourself? A few things to consider:

Do you have the skills to pick shares?

What a fantastic boost to the ego it will be if your share portfolio performance beats Allan Gray or one of the other award-winning unit trust managers. But unless you know how to analyse a company, accurately estimate its future cash flow and evaluate its business strategy, chances are slim you’d keep it up over the long term.

While I find it great fun to trade my own shares, I have no delusions. My share picking skills are not on par with award-winning investment houses with their CFA-qualified and experienced teams.

Do you have the time to manage shares?

Following company news and calculating whether the share price adjusted appropriately is a full-time job. Unit trust managers have whole teams focusing on the shares in a specific sector. They have the time to visit companies, attend shareholders meetings and ask the difficult questions.

How much are you spending on trading costs?

Because share trading costs generally form a larger percentage of the trade with small amounts, and you often pay a minimum amount (e.g. R120 with ABSA), you could end up paying away more than 1% of the trade for transactions smaller than R12 000. Unit trust fund managers, on the other hand, pool your money with other investors and negotiate much lower trading fees with their brokers. However, what you score in trading costs, you could lose in investment management fees, which are automatically deducted from your unit trust investment every year.

Does SARS view your trading profits as income?

If you are someone who won’t draw the money in your trade account within three years, but believe in frequently trading shares to benefit from short-term price fluctuations, you may find you’re paying less tax if you outsource the job to a unit trust manager who has the same short-term, opportunistic approach. That is because SARS is likely to view your trading profit as income if you sell your private account shares within 3 years of purchase. If you’re in the top tax bracket, this means you have to pay SARS 40% of the profit.

But unit trusts managers can trade the shares as often as they like – they don’t pay tax on their gains in the portfolio. You pay tax on the growth in the unit trust price from the time you invest until you eventually withdraw your investment. If you keep it for longer than three years, SARS views the growth as a capital gain and not as income – even though the fund managers had the freedom to sell shares whenever they saw opportunities. This means you could pay four times less tax than if you traded the same shares yourself.

How much risk do you want to take on?

Unit trust funds are usually well diversified and invest in portfolio of at least 20 shares. This diversification decreases your investment risk. It’s therefore unlikely that you will lose 80% of your money in one year; it’s also unlikely that you will gain 80%. With your own share portfolio you don’t have the restrictions of the Acts regulating unit trusts and can hold only one share in your portfolio, if that’s what you want.

If you’re either a speculative, high-risk investor or a semi-retired portfolio manager, a share trading account will probably appeal to you more.

The Satrix products seem to be very popular with passive, index-tracking share investors in South Africa; the spacious seminar venues for the launch of the Satrix RAFI 40 were fully booked. But does this fundamental indexation product even belong in the index-tracking family? And is it the most affordable South African product pursuing fundamental indexation goals?

What is fundamental indexation?

One of the criticisms of just tracking an index, is that you by definition buy all shares in the index (e.g. the ALSI 40) indiscriminately. If there is a lot of hype or speculation around certain shares and they start to form a larger portion of the index as they become more expensive, you are buying potentially over-priced shares. Fundamental indexation tries to exclude these over-priced shares from your portfolio by looking at fundamental factors (the figures in the company’s financial statements).

Research Affiliates in the US developed the RAFI® methodology to include only shares that look promising in terms of the following fundamental factors of a company:

• sales
• cash flow
• book value
• dividends

Because it uses fundamental factors, fundamental indexation is closer to active management, and not passive index-tracking. These are the same factors that active managers look at when they construct a portfolio.

But fundamental indexation differs from most actively managed share portfolios in that it is quantitatively managed. This means that a mathematical software package can analyse the fundamental data and build the RAFI® portfolio. There is no or little human involvement.

What are the pros?

1. Cheaper than active management

Because there are no portfolio managers and analysts that analyse data and visit companies daily (and need to get paid), the costs are normally lower than non-quantitative active management.

2. Less likely to buy over-priced shares

The software will not always get it right, but it decreases your chances of buying hyped shares.

3. A chance to out-perform the equity index

You only get an opportunity to out-perform the index when your portfolio differs from the index.

What are the cons?

1. More expensive than index-trackers

There is usually an annual license fee for using the RAFI® technology – a lucrative business model for Research Affiliates. There are also more brokerage costs due to the re-investment of dividends. Therefore a RAFI product will cost the investor more than an index-tracking product.

2. No human judgement

The computer software will not know the story behind a company’s financial statements or the management’s vision and strategy. It only looks at past data and will not understand why the data looks the way it does.

3. The risk of under-performing the equity index

This is the flip-side of the third advantage listed above. You can only under-perform the index when your portfolio differs from the index.

Which South African products offer fundamental indexation?

1. Plexus Rafi® 40 SA Enhanced Strategy Fund

Plexus has exclusive rights to offer the enhanced Rafi® 40 technology in Africa. By ‘enhanced’ they mean that they have taken the plain vanilla methodology and adjusted it for South African circumstances. Sales and cash flow, for example, are more important fundamental factors locally. It selects the 40 most promising shares from the 100 largest companies listed on the JSE and re-balances quarterly. The total expense ratio (TER) on their August fact sheet is 1.15%.

2. Old Mutual Umbono RAFI® 40 Tracker Fund

Old Mutual Umbono applies the plain vanilla Rafi® 40 technology, which rates sales, cash flow, book value and dividends as equally important fundamental factors. It looks at all companies listed on the JSE when it selects the 40 most promising shares and re-balances once a year. The TER on their June fact sheet is 0.93%.

3. Satrix RAFI 40

When it lists on 16 October 2008, this product will use the same plain vanilla technology as Umbono, but it is an exchange traded fund and not a unit trust, like the Plexus, Umbono and Nedgroup Investments funds. Satrix does not expect the fund to have a TER higher than 0.7% per year. In addition, if you buy this product through the Satrix Investment Plan, there is an annual administration fee of 0.8% if you have less than R100 000 invested. For larger amounts, the administration fee decreases according to a sliding scale until it reaches 0.45% per year. Brokerage is 0.1% of all purchase and sale amounts.

4. Nedgroup Investments Quants Core Equity Fund

This fund uses Taquanta Asset Managers’ price-indifferent technology to quantitatively build an equity portfolio. Their way of thinking is similar to Research Affiliates, but they developed their own technology. Interestingly, the fund doesn’t use the FTSE/JSE All Share Index or the ALSI 40 as its benchmark, but rather the average general equity unit trust portfolio. The TER on its August fact sheet is 1.17%.

How does the past performance look?

The South African products do not have long enough track records to reach a meaningful conclusion. Some of the product providers will show you back-tested (simulated) performance graphs. While I want to give them the benefit of the doubt, this is not real performance with real money. The verdict is still out on who has the top-performing fundamental indexation product. Even though there is no human involvement with fundamental indexation fund management, the performance will only be as good as the methodology developed by the people involved.

So, you’ve decided you have enough time to sit through all the ups and downs of the stock market and hope that handsome returns will reward your patience. I bet you’re getting plenty of contradictory advice from other share investors, who seem to be divided into two main camps: the index-trackers versus the believers in active equity management.

What is the difference?

With index-tracking you buy all the shares in the index in the same weightings as that index. If you track the FTSE/JSE All Share Index, for example, your index-tracking fund will invest in all the shares listed on the JSE and if Anglo American makes up 20% of the JSE, your fund will allocate 20% of its capital to Anglo American. In other words, index-tracking funds just replicate an index and their managers don’t have to decide which shares offer value for money. They are therefore also called passive managers.

Active managers, on the other hand, seldom buy all shares in the index and if they think Anglo American is too expensive relative to its anticipated future earnings, they may decide to invest only 5% of the fund in this share, for example. Conversely, if they think a share is cheap, they may buy more of it than its percentage weighting in the index. They have the freedom to actively pick shares in quantities that they think suit the shares’ value-for-money ratings.

To choose active management, what do you have to believe?

1. Shares are not perfectly priced all the time

Active management only makes sense if you believe that the market does not price companies correctly over the short term, which offers opportunities to buy under-priced shares.

2. Managers who consistently out-perform the market exist

Sobering slide 5 in the latest Nedgroup Investments September 2008 Partnerships Roadshow presentation shows that over the past seven years, the average equity unit trust manager returned 22% after fees – the same as the JSE All Share Index. Active management seems less futile when you think that, if about half the managers under-performed, half of them had to out-perform the Index. In other words, out-performing managers exist, but are they consistent?

I don’t expect a fund manager to out-perform every year. In fact, studies show that for a fund manager to out-perform over the long term, he often has to take contrarian views, which could frequently make him one of the worst performers over the short term. Your typical active manager expects the value of his chosen shares to unlock after three to five years only. With ‘consistent out-performance’ I therefore mean out-performance on a rolling 5-year basis.

3. You know who the out-performers will be

You should be able to get hold of the names of the rare few managers who have consistently out-performed on a rolling 5-year basis over the past 20 years. But that is historic performance. Do you believe that they will continue to out-perform?

4. The out-performance will out-weigh the higher costs

When you compare past performance, remember to look at the return after all fees and fund expenses were deducted. Generally, active managers are more expensive than index-trackers due to the time that they spend on researching and valuing companies.

When you choose passive management, what are you settling for?

1. Average stock market performance

While there’s little risk of investing in the worst-performing equity fund, you have no opportunity to out-perform the stock market either.

2. No way to detect and avoid market hype

It is a mistake to think that index investing is less volatile than active investing. When the stock market or one specific sector (e.g. IT) moves into ‘bubble’ territory, you automatically buy those over-priced stocks as part of the index. And experience the subsequent price correction.

How do you access active management?

1. Unit trusts

There are almost as many actively managed unit trusts as there are shares listed on our JSE. You can familiarise yourself with the managers by reading about their process and philosophy and studying their fund fact sheets. Equinox provides an on-line list of most South African unit trust portfolios.

2. Your employer’s fund

Maybe your employer’s pension or provident fund offers member choice. In other words the fund trustees allow you to pick the underlying portfolio from a shortlist. I would expect at least one of the options to be an actively managed fund, but its equity exposure will probably be limited to 75%.

3. A retirement annuity

Many modern, flexible retirement annuities allow you to choose your own underlying investment portfolio and an actively managed fund should be one of the options. As far as I know, Allan Gray is currently the only company that allows you to choose a 100% equity portfolio if you invest in their retirement annuity.

4. Your own share trading account

If you have the time and skill to analyse companies yourself, you could also build your own equity portfolio with an online share trading account. Just keep in mind that the tax treatment of trading profit is not always as favourable as with a unit trust portfolio or retirement annuity.

How do you access passive management?

1. Satrix

Satrix has created exchange traded funds (EFTs) which invest in the main South African equity indices. The Satrix 40 fund has a total expense ratio of 0.37% – a good selling point. But if you invest through the Satrix investment plan, the annual administration fee is 1.0% of the market value of your investment! In addition, your brokerage fee on any purchase or sale is 0.1% per transaction. For large investment amounts, it may be cheaper to use a stock broker rather than the Satrix plan. Also, your dividends don’t automatically get re-invested when you invest in the Satrix 40, but are paid to you after costs. This means your capital grows slower than if dividends were re-invested.

2. Unit trusts

There are a few unit trust portfolios that track the JSE All Share or the ALSI 40. Currently, Gryphon’s All Share Tracker Fund seems to offer index-tracking at the lowest cost: a total expense ratio of 0.69% and no initial fees.

3. Your employer’s fund

If your employer’s retirement fund offers member choice, I’d expect them to also offer a low-cost index-tracking option as one of the options.

In the next post we’ll have a look at the new investment methodology that tries to keep over-priced stocks out of your portfolio: fundamental or risk-adjusted indexation.

You’ve decided which asset class and investment product suit you. It’s time for your last main investment decision.

Which product house?

The product provider could be a life assurer, a unit trust management company or a linked investment service provider (LISP). When choosing product providers, look for companies that are:

1. Focused on small, retail clients

Many companies claim that you, the retail investor, are important to them. In reality, they prefer to take your money through intermediaries like financial advisers or retirement fund trustees, rather than dealing directly with you. Signs that they are not really that interested in direct clients include:

• Very little investor education literature
• A poorly staffed call centre and irritable staff
• A website that provides very little practical information on the investment process
• No clear communication, a.k.a. simplified English policy
• An almost immediate referral to a financial adviser when you contact them

Most companies seem to still believe that dealing with direct clients is too time-intensive and expensive. A rare few know how to leverage modern technology to cost-effectively service even the smallest retail investor well.

2. Fit and proper

With unit trusts, it’s highly unlikely that your money can just disappear. The Financial Services Board approved the independent trustees who look after the money in the trust. Still, it’s always important to verify that the company you want to invest with, is fit and proper. I usually check that they at least have a licence with the Financial Services Board and read on HelloPeter what existing clients are saying about them.

3. Flexible

I choose companies that, irrespective of the investment product I choose, provide me with ‘open architecture’ to build my own underlying investment portfolio. If I, for example buy a retirement annuity, I want access to any one or a combination of unit trusts available in South Africa as the portfolio in which my portion of the retirement annuity fund will invest. Just be careful, if the product provider has an in-house investment manager, you may pay extra (in the form of an administration fee) if you prefer a third-party investment manager.

4. Transparent

Ideally, you want to be able to see a list of all the underlying assets in which your investment product invests, as well as all the expenses associated with the product. It’s very difficult to know exactly how much of your investment portfolio is paid away as expenses and administration costs if you invest in opaque old-fashioned policies. But if you choose an open architecture product, you can track the total expense ratio (TER) of your chosen underlying unit trust portfolio.

5. Affordable

With unit trust portfolios, the total expense ratio (TER) is a ratio expressing the investment management fees, audit fees, custodian fees, portfolio bank charges and taxes as a percentage of the market value of the portfolio. (These costs decrease the return on your investment.) The ratio changes every quarter and is based on the previous year’s expenses. The TER does not have to include the portfolio’s stock broking fees and these can be quite high if the investment manager trades often. Some companies, like Allan Gray, decided to include brokerage in their TER calculations to give the investor a better idea of the true costs associated with running the unit trust. This makes it more difficult to compare the cost of different unit trusts using their TERs, but generally unusually high historic TERs require further investigation.

The TER does not include all costs carried by the investor. You could also be paying a fee to a life assurer for providing the wrapper of your investment. Or an administration fee to a LISP for acting as an agent in the investment process. And if a financial adviser helped you with your application process, you could also be paying initial and ongoing adviser fees (also called ‘broker fees’). The adviser has to disclose these costs and you will have to sign on the form that those are the fees that you have negotiated.

The life insurance industry uses another ratio, the reduction in yield (RIY), to indicate the annual impact of expenses on your investment. Unfortunately, this is not comparable with the unit trust industry’s TER. It’s a good idea to always ask for a complete cost breakdown for all products that you are considering. In the case of open architecture products, also enquire whether the underlying portfolio pays a rebate to the product house from which you’re buying the product and whether that rebate is passed on to you in the form of lower costs.

That covers your five big investment decisions. You probably have plenty more questions like ‘Satrix or unit trusts?’, ‘your own share trading account or someone else’s fund?’, ‘direct or listed property?’ We’ll cover these asset class-specific questions over the next few weeks.

Which investment product?

Foreigners are often surprised at the sophistication of the South African financial industry and the wide array of products available here. Don’t worry, I won’t cover them all in this post; only the three most popular ‘wrapper’ products available to individuals.

What is a wrapper? Your investment portfolio forms the heart of your investment. In other words, your choice between interest-yielding assets, shares, property and offshore assets drives the growth and volatility of your investment. The structure around your portfolio is the wrapper. Your choice of a wrapper will determine how your investment is regulated, when you may withdraw your money, how much tax you pay on income and capital gains, and many other issues that surround your investment.

1. Unit trusts

Unit trusts allow you to pool your money with many other investors, all investing in the same portfolio as you. The portfolio can consist of only interest-bearing assets, property, shares, offshore assets or any combination of asset classes. The assets are held by trustees on your behalf. You share in the growth and income of the portfolio in the same proportion as your number of units to the total number of units in the portfolio. You can access your money within 24 hours and add money to your investment at any time.

Unfortunately, you don’t get any tax-relief for your contributions and you become liable for capital gains tax when you withdraw your money (if there was any capital growth). You will also receive a certificate every year to show how much interest, rental or dividend income the portfolio earned and you have to declare this in your tax return.

Unit trusts form part of a bigger group of investment products called ‘collective investment schemes’ and they are regulated by the Association of Collective Investments. Their prices are published daily in most newspapers and you can view all the assets in the portfolio at least quarterly.

2. Retirement annuities

Technically, buying a retirement annuity actually means you become a member of a specific retirement fund. The fund’s trustees look after your interests. Sometimes the trustees buy an old-fashioned retirement policy on behalf of all members or an individual policy for each member. Often the policies contractually bind you to contribute premiums on a regular basis until a certain retirement age and penalise you if you stop contributing earlier. The life insurers issuing the policies usually appoint asset managers who choose the underlying investment portfolio.

Nowadays there’s a more modern, flexible and transparent version of the retirement annuity which allows you to choose your own investment portfolio (often a unit trust) and also allows you to contribute only when you can – without penalties. Still, neither version allows you to withdraw your money before you reach age 55. The age is determined by retirement fund legislation.

Why would anybody choose to be locked in for so long? Retirement annuities currently provide great tax benefits for the self-employed, as the government wants to encourage you to save for old age. As a tax-payer, you may therefore receive a tax rebate on your contributions, subject to certain limits. In addition, neither you nor the retirement fund pays any tax on the income earned by the investment portfolio. It’s only when you start drawing your pension, that you could pay tax on your retirement income exceeding the annual income threshold.

Unlike unit trusts and endowment policies, regulation requires the trustees to use their discretion when they decide who your dependents are and where the money should go after your death. As a result, they may overrule your beneficiary nomination.

3. Endowment policies

Like the old-fashioned retirement annuity policies, endowment policies have become unpopular because of the high penalties life insurers charge when you end the policy or stop your regular contributions before the contractual end date. Traditional endowment policies also do not allow you to select your own underlying investment portfolio and don’t always regularly disclose all assets in the portfolio they select on your behalf. Legislation effectively forces you to remain invested for five years. If you need the money earlier, you can withdraw it, but won’t receive more than your contributions plus 6% compound interest per year.

With all these restrictions, why do some people still prefer this wrapper? Unlike unit trusts, you don’t account for your investment income and capital growth in your tax return. In other words, you are not taxed directly; the fund that pools your contributions with that of other individual policyholders will pay the tax to SARS on your behalf. Currently the rate is 30% on all interest and rental income. Even though you are not taxed directly, the net effect is that you are left with only 70% of the interest and rental income earned by the portfolio. Individuals paying more than 30% tax on their annual interest and rental income may therefore benefit from the 30% tax rate of the endowment policy. Unfortunately, the policy doesn’t allow you to use your R19 000 annual interest exemption as an individual – interest earned by the portfolio is taxed from the first R1.

An endowment policy is therefore only an option if:

• You are a high income tax payer
• You expect substantial amounts of interest or rental income from your investment portfolio

Endowment policies have also evolved over the years. It is now possible to purchase policies that allow you to choose your own underlying investment portfolio, often from a wide range of unit trusts. Because the unit trust is wrapped within the policy, it follows the tax and other rules of an endowment policy, but offers the transparency of a unit trust investment.