In a world that often seems frighteningly uncertain, change over which we have little or no control is a huge source of stress. With your finances, as in other areas of life, it’s often as unwise to overreact to change as it is to bury your head in the sand and ignore it.
In a talk this week for PPS, the financial services provider for professionals, former Personal Finance editor Bruce Cameron examined the types of change that pose a threat to your financial security.
He says that planning your finances is like going to war: you need an overall strategy on how to reach your target, but you must also be able to adapt when confronted with changes that will affect the outcome. Some changes require immediate action, but for others the wise thing to do is act slowly and cautiously.
Cameron says the variables you need to consider when dealing with your finances are: taxes, your personal circumstances, how long you live, inflation, interest rates and investment markets.
This is one area in which, if there are changes, you need to act immediately, Cameron says, both to avoid paying too much tax and to take advantage of new or revised tax breaks.
He showed how tax rates have changed since the 1970s. Between 1971 and 1979, the top marginal income tax rate was a staggering 60 percent. However, there was no sales tax or value-added tax (VAT) in those days. General sales tax (GST) was introduced in 1978, and in 1980 the top marginal rate came down to 50 percent, and then down to 44 percent when VAT (at 10 percent) replaced GST in 1991. In 1993, VAT increased to 14 percent, where it has remained, and in 2003, the top marginal rate came down to 40 percent, where it remained until last year, when it went up to 41 percent.
Capital gains tax (CGT) has increased substantially since its introduction in 2001. At that time, the annual exclusion was R16 000, and the inclusion rate (the portion of the remainder subject to income tax) was 25 percent. Today, the annual exclusion is R40 000, but the inclusion rate is 40 percent.
Duty on property transfers has also increased in leaps and bounds, especially for high-end properties. For the 2014/15 tax year, the top rate was R37 000 plus eight percent of the value over R1.5 million on properties of over R1.5 million. For the 2016/17 tax year, the top rate is R937 500 plus 13 percent on the value above R10 million on properties of over R10 million.
Cameron says the tax regime is highly dynamic, and changes require an immediate review of your financial plan, preferably with the help of a professional planner. Solutions include considering the full range of financial products available to you and their tax implications, and taking maximum advantage of tax breaks, such as the amount you can deduct from your income for retirement savings and the annual CGT exclusion.
For example, with high CGT, it is beneficial for a pensioner first to consider drawing on discretionary investments, while leaving more savings in a retirement fund or living annuity until the discretionary investments have been depleted.
CHANGING PERSONAL CIRCUMSTANCES
Your financial needs change as you progress through life: starting work, getting married and having a family, getting promoted, seeing your children leave home, retirement and death. Divorce, retrenchment, or disability or early death from accident or illness can hit you along the way. From these unanticipated adverse events, you need to protect yourself and your family, and for this you need life assurance.
Cameron says that, according to the Actuarial Society of South Africa, of the 14 million income earners in South Africa between the ages of 18 and 65, about 140 000 were expected to die and 46 000 to be permanently disabled in 2016. The majority of these earners are under-insured for death or disability: people earning R500 000 a year typically need life cover of about R4.5 million. On average, however, they have only R2.1 million in life cover. The gap for disability is even larger: R2.7 million instead of the R6 million they require.
Cameron says life assurance and medical scheme cover is essential, but warns that you need to strike a balance between having too much cover (leaving too little income for other needs) and too little (leaving too much risk for your family).
Many pension plans use an average age of death of 84 years in their calculations. But your financial plan shouldn’t be based on an average, Cameron says, because half of the population on which the average is calculated live longer than the average. With medical advances, people are generally living longer, and professional people live longer than average because they tend to have healthier lifestyles and can afford a high standard of medical care. The first person who will live to the age of 150 is already older than 50, he warns.
INFLATION AND INTEREST RATES
Inflation affects you in an obvious way, which is the loss of buying power of your rand.
The rand has lost 90 percent of its value in the past 30 years, Cameron says. What cost you R100 in 1986 now costs over R1 000.
But inflation has a surreptitious side-effect: fiscal drag. Fiscal drag is the taxman’s friend, Cameron says. It is the rate at which the income tax brackets and tax exemptions and allowances do not keep up with inflation, hence pushing up the tax you pay in real terms.
To fight inflation, you cannot be too conservatively invested. Looking at interest and inflation rates over the past 57 years, you would not have outperformed inflation most of the time if you had been in an investment that returned the prime rate minus three percent, for example, which would be typical of a bank deposit.
It is in the area of investment performance that investors often over-react, and it is here that you really need to act slowly and cautiously, if at all, Cameron says.
Markets rise and fall, with different asset classes performing well and badly at different times.
Looking just at the local equity and bond markets, over the five years ending December 2016, South African equities returned 26.7 percent (2012), 21.4 percent (2013), 10.9 percent (2014), 5.1 percent (2015) and 2.6 percent (2016), while South African bonds returned 15.9 percent (2012), 0.6 percent (2013), 10.1 percent (2014), –3.9 percent (2015) and 15.4 percent (2016).
Asset managers are also inconsistent, as the past results of the Raging Bull Awards show. For example, Allan Gray was the top South African unit trust manager for four years in a row, from 2008 to 2011. In 2012 and 2013, it was in second place, in 2014 it dropped to fourth place, rising to third place in 2015, and it regained its top position last year. If you were in an Allan Gray fund in 2014 and overreacted by pulling out your money, you would sorry today.
Cameron has the following tips:
• If you make considered investment decisions to begin with, there’s often little reason to move or switch investments;
• The best guaranteed return you can get is to pay off your debt;
• Avoid complex products – complexity normally hides hazards;
• Diversification – investing across asset classes – has been shown to reduce risk and benefit you over the long term; and
• Promises of exceptional returns come with exceptional risk – but sometimes even promises of only slightly higher returns come with exceptional risk, as was the case with property syndications.
Ultimately, you need to have a plan and, to help you, the best person to use is a financial planner who has the Certified Financial Planner accreditation.