If you feel you’ve invested enough in yourself and your debt is under control, it’s time for the next decision:

Which asset class?

Let’s leave the alternative asset classes like hedge funds, derivatives, commodities (e.g. gold), private equity (e.g. venture capital) and collectibles (e.g. art and coins) out of the picture for now and start with the basics – the traditional asset classes:

1. Money market (cash)

Put simply, this is where you sell your money to an institution in return for interest and the repayment of the loan within one year. Depositing your money in a savings account is a money market transaction. So is pooling your money with other money market unit trust investors, which allows you – through the trust – to buy a variety of cash-like instruments that are not normally available to individual investors.

Looking at the data in Triumph of the Optimists, the money market has returned about one percent more than inflation per year, on average, over the past century. But if you’re a tax-payer and younger than 65, you’re currently taxed on all interest above R19 000 per tax year. If you’re investing large sums, you could therefore be left with a return that’s not even keeping up with inflation. On the other hand, money market is the most stable of all investment options (the value of your investment doesn’t fluctuate much).

The money market is therefore great for those who:

• Need a short-term parking bay for their money
• Invest small amounts on which the interest will be less than the R19 000 annual tax threshold
• Can’t stomach the volatility of the other asset classes
• Have a more pessimistic view of world markets and believe that the historically better investment returns of the other asset classes won’t be repeated over the next few decades.

2. Bond market

Like the money market, this is a market in which you lend your money in return for interest, but the term of the loan is usually much longer. And there’s no guarantee that you’ll get back the same amount as your capital invested, as the capital value of the investment fluctuates. The borrowers could be governments or big corporates raising finance through bonds rather than issuing more shares. Usually, the higher the interest rate being paid, the higher the credit risk of the borrower. Credit risk indicates the likelihood of the borrower not being able to repay the debt.

Over the past century, the bond market has, on average, returned about two percent more than inflation per year before tax. (The tax on income from bond instruments works the same as for the money market.) But the uncertainty of return is much higher than in the money market. For example, during the first six months of 2008, our All Bond Index returned -6.7%.

The bond market is perhaps more appropriate for investors who understand credit risk and the impact of interest rate movements on the bond market very well. Less experienced investors who want a slightly higher return than money market may want to out-source the decision between money market and bond market to flexible income unit trust managers. Their job is to analyse the prices of money market and bond market instruments, and then invest in those that they think offer the best value for money. As a result, the portfolio is often exposed to the best of both asset classes.

3. Property market

If investing directly in property, you earn income in the form of rent and hopefully also see some capital growth (an increase in the property’s value). Your return on your investment is a combination of these two factors. Property indices returned about five percent more than inflation per year, on average, over the past few decades. Property prices can also decline for uncomfortably long periods, but they are not as volatile as equity prices.

Unfortunately, this market has high minimum investment amounts (not many properties left under R500 000). Most people therefore have to get a mortgage and it can take quite a few years before the rental income exceeds your bond repayment, levies and taxes. Direct property investment is also relatively illiquid. In other words, it could take a while before you are able to sell at a reasonable price. Alternatively, if you want to use less capital, you can opt for a property unit trust (PUT) or buy units in property loan stock (PLS), where you pool your money with other investors also wanting exposure to the property market.

4. Equity market

Here you buy a share in one or more companies. When they make a profit and don’t need the earnings to expand the business, they pay you a dividend. Hopefully, your share price will also increase as the company grows, but share prices can be much more volatile than bond or property prices. Your return on investment will be a combination of the dividends received and the change in the share price. Over the past century, equity markets have returned about seven percent more than inflation per year, on average. But over the short term they could lose a lot of value – as much as 50% or even more.

A 10% tax on dividends is in the pipeline, but this will only replace the current secondary tax on companies (STC), which is also 10%. The net impact on shareholders should be the same.

The equity market suits those who:

• Don’t need the capital within the next 10 years
• Can stomach volatility of share prices
• Believe that markets haven’t changed structurally and that the equity market will continue to be the best performer over the long term.

5. Offshore markets

The South African equity market forms only 1% of the world market and investing internationally can be a great way to diversify your portfolio. And the more the rand depreciates, the more your investment is worth in rand terms.

But if you only invest offshore, you should prepare for some turbulence. Even if you invest in the stable money market offshore, you will witness the rand value of your investment zig-zag from one day to the next. That’s because the exchange rate is so unpredictable over the short term. If you therefore invest offshore in a more volatile asset class like equity, you could see even bigger changes in the rand value of your investment. Over the long term, in theory at least, the rand is suppose to depreciate against the major world currencies at a rate equal to the difference between our inflation and the inflation in their countries.

Back to our question: Which asset class?

If you will need your savings within the next year and tax is not an issue, the money market is your safest option.

If you have money you won’t need within the next 10 years, and you want to diversify your portfolio, you may be interested in all three of the riskier asset classes, i.e. property, equity and offshore assets.

If you think you’ll need the money within the next two to 10 years, your decision becomes tougher. A flexible income or a low-equity portfolio (no more than 40% in equity and the rest in money market) should provide a slightly higher return than the money market – if you stay invested for a few years. More equity in your portfolio increases the volatility of your investment, but also the potential for a higher return.

While a whole century of performance data for each asset class shows the long-term picture, it unfortunately can’t guarantee your future return.

You’ve got some spare cash. It could be a lump sum windfall or you may find that you consistently have some money left at the end of every month. You could invest it, but your outstanding debt is bugging you.

Should you settle your debt first?

If I was working for a big financial institution, telling you anything other than ‘Yes’ would probably get me fired – or reprimanded at the least. It’s regarded as irresponsible to encourage people to borrow to invest, which is effectively what you’re doing if you’re investing while you still have debt. But I believe the answer is not that simple and there are a few issues at stake, such as:

1. Return on investment (ROI)

What is your borrowing rate? If you owe money on your credit card at 23% interest, settling your debt would have the same effect as an investment with an ROI of 23%. (Think of it this way: If you owe R10 000, you would have needed to pay R 2 300 interest on that over the next year. By ‘investing’ R10 000 in your credit card debt, you are left with R2 300 extra in your pocket over the next year – an ROI of 23%).

Do you know of any investments that could beat your borrowing rate? According to Triumph of the Optimists, equity returned about 7% more than inflation, on average, over the past century. This makes it the best-performing asset classes over the long term. With inflation hovering just above 10% at the moment, settling your credit card (or other expensive) debt first is a no-brainer. But what about a home loan with a borrowing rate of 14%? Surely, you can find an investment with a higher ROI, you may think. But are you comparing apples with apples? With the other investment, how certain are you of your ROI?

2. Uncertainty (a.k.a. ‘risk’)

When you settle or reduce your debt, your return is guaranteed at the rate of borrowing. On the other hand, if you choose to invest in property or the stock market, there are many uncertainties. Are we heading for a long-term recession like the world’s 2nd largest economy, Japan, which could suppress the stock market for longer than you expected? Will you always have tenants providing you with steady income on your property investment? What is the next version of the current sub-prime crisis and how will it impact on your investment?

3. Cash flow

Do you have enough emergency cash in a money market unit trust or another easily accessible and stable investment product? If not, you may want to rather keep your spare cash for any unforeseen events that could really hurt you financially. Do you perhaps have a home loan account that allows you to withdraw any extra payments within 24 hours? Transferring your extra cash to this account could provide a really good, tax-free return, with the benefits of an emergency fund.

4. Tax

If you are considering investing your spare cash, how much tax will you pay on your return? Any interest and rental income over your annual allowance of R19 000 will be taxed at your marginal tax rate (the rate of your tax bracket as determined by SARS). In contrast, your return on your debt settlement is tax-free.

Have you looked at the flip-side of our tax system? Are there any investments that could provide you with some tax-relief? In other words, the more money you invest, the less tax you pay. Retirement annuities (RAs) immediately jump to mind. Liberty, for example, launched a quirky, but memorable ‘Love the Taxman’ campaign earlier this year to remind you that you can contribute 15% of your non-pension funding income to an RA and deduct those contributions from your taxable income when completing your tax return. If you’re in the 40% tax bracket, you could see an ROI of 40% due to the tax-rebate alone, and that’s before adding the growth of your RA investment over the year. I don’t know for how much longer this opportunity will be available, though. Policymakers are working on new legislation that will limit the RA contributions on which you can claim tax-relief, as there have been complaints that current legislation favours high income earners.

5. Time

Debt can keep you in a job you don’t really enjoy or make you postpone those full-time studies or travelling which you’ve been dying to undertake for so long. The sooner your debt is under control, the sooner your time is your own again.

6. Emotional benefits

Let’s face it, being debt-free can be pretty euphoric. While encouraging you to look at the hard figures like ROI and tax benefits when weighing your options, sometimes getting those shackles off is about more than just the money.

MoreThanMoney members seem to have plenty of investment questions. Thanks, these inspired me to write the next few posts on the most important investment decisions you may need to make along the way to great wealth.

Have you invested enough in your own earnings potential?

Maybe you find the whole idea of investing quite depressing. Everybody else talks about the right time to buy property and which shares are cheap right now. But you struggle just to get by every month – not able to save anything, let alone buy your own property? Or you save and save but it all feels like a drop in the ocean compared to the sums you would need to realise your dreams.

You’ve already cut your budget to the bone and further skimping would actually not make live worth living. But how about increasing your earnings potential? No need to remind you: you can only invest when you have enough disposable income. If you still have several working years left, your most important investments right now may be to:

1. Get a further education

The 7th UASA Employment report of 2007 states that someone with a bachelors degree earns more than 250% more than someone with only matric. The salary for a worker with only grade 11 nearly doubles when he or she completes matric. Yes, a tertiary education costs money, but over a normal lifespan a person with a degree will see a return on that investment that’s 308% higher than the return on investment of someone who did not continue studies after matric. Currently, a bachelors degree through Unisa costs around R16 000 (excluding books) which looks even more affordable when you consider that the tuition fees are spread over several years of study.

2. Welcome more experience

Irrespective of the level of your schooling, are you constantly trying to learn as much as you can on any job in which you may find yourself? In fact, are you thinking about long-term earnings when you choose your roles or projects? The pay may be poor for a year or two, but the experience could be worth millions of future earnings.

This is what Donald Trump has to say about the value of experience: ‘A couple seasons ago, we based an entire season of The Apprentice on this premise, pitting highly educated candidates against those with less formal schooling. In the end, we discovered that the key to success was experience, not education. Experience comes from action – or doing – and involves taking risks.’

3. Boost your confidence

Do you have a career handicap, such as a fear of public speaking or numbers? Ever considered coaching or private lessons? Even conquering only one fear can boost your confidence in all other aspects of your job.

Your skill-set and experience remain your greatest assets while you still earn active income. And you may even find that as your income rise, those boring investment topics start to appear more and more interesting to you!