Email your queries to [email protected] or fax them to 021 488 4119. This feature is sponsored by PSG Wealth.
SAVING FOR MY FIRST MILLION
I want to save towards my proverbial “first million rand” over the next two years. How can I do this? My rationale is if I can create capital of R1 million, I can earn a tidy monthly income from the interest. Is this a reasonable idea? I have a disposable monthly income of R30 000.
Alexi Coutsoudis, a financial adviser at PSG Wealth in Umhlanga Ridge, responds: To answer your questions, and for the sake of brevity, I will have to make a few assumptions about inflation, investment growth rates, and so on.
Before you make any decisions, I advise that you contact an adviser with the Certified Financial Planner accreditation, who will be able to craft a financial plan tailored to your circumstances.
You may have heard the saying, “your first million is the hardest”. The reason it is so tough to save towards your first R1m is mainly because time and compound interest are your greatest assets when you invest. However, you have neither on your side when you first start saving. But don’t despair; it gets easier.
For example, someone who has R10m invested in an average balanced (multi-asset) unit trust fund would have seen growth of R1m (10%) on his or her investment over the past year, without saving a cent.
If we assume you save R30 000 a month and the investment grows at 10% a year (the Consumer Price Index plus 4% a year), it will take you about 30 months, or two-and-a-half years, to reach R1m. Bear in mind, however, that in two-and-a-half years R1m will not be worth what it is today. For this reason, some investors save in a hard currency such as the United States dollar, which historically has held its value much better than an emerging-market currency such as the rand.
Drawing an income from an investment is not as easy as you may think if you want your capital to last.
The most important aspects to bear in mind when planning to draw a sustainable income from an investment are:
• Inflation reduces the value of your investment every year. The real (after-inflation) value of your R1m investment will drop by about 6% every year. Furthermore, your personal inflation rate may be higher than the official rate.
If you want your capital to remain intact and hold its value, you should draw only the percentage by which your investment grows above the official inflation rate. For example, your R1m investment grows at 10% a year (R100 000) and inflation reduces the value by 6% (R60 000). Therefore, your income drawdown should be less than 4% (R40 000) in that year. At the end of your first year of withdrawing an income, the value of your investment will be about R1 060 000, which in real terms will be about R1m.
• Your age. It is crucial to get the assumptions around longevity and life expectancy right. For example, the appropriate drawdown for a 55-year-old will be very different to that of a 65-year-old. It is often best to plan on the basis that you will live a few years longer than you think.
• The level of risk you take on when you invest your money every month. There are more than 1 000 local unit trusts to consider, and this ignores bank savings accounts and direct investments in shares. Getting the risk assessment wrong can have devastating effects on your wealth over time.
Risk is often misunderstood by investors, who assume it means capital loss, whereas it actually relates more to volatility and consistency of returns. For this reason, as a general rule, the longer your time horizon, the greater the volatility or risk you can carry.
For example, if you leave your investment in a money market fund, the return will be about 7% a year, but, because the interest is taxable in your hands, the after-tax returns are often below inflation and therefore you are losing money before you even withdraw from your investment.
On the other hand, unit trusts that invest in equities, for example, can drop in double digits over short periods. Therefore, your investment horizon should be carefully considered to ensure the correct level of risk is assumed to meet your goal.
IS MY HOMEOWNER'S COVER HIGH ENOUGH?
I wonder whether the insurance cover that came with my home loan is enough. It escalates each year in line with inflation, so I imagine it is sufficient. Is there anything else I should consider?
Sonet Swart, the head of claims at PSG Insure, responds: Your property may be covered only to its market value, which may not be sufficient if a disaster, such as a flood or fire, occurs. Apart from what it will cost to rebuild, you need to factor in the cost of demolishing what might be left of your property, clearing the rubble and having building plans approved. Plan approvals can take time, so you will need temporary accommodation, which will be an added expense.
Insurance on your property should be calculated by looking at the replacement value based on the current building costs per square metre, as well as the fixtures and fittings. It is essential to make sure that your home is insured at its correct replacement value. If you have outbuildings or a swimming pool, for example, these add to the value and must be included.
Check that the construction of the building is noted correctly on your policy schedule. Also remember that thatch-roof lapas must be specified separately. If the size of a lapa is more than 15% of the roof surface of the main residence and is within four metres of the main house, the main residence will be regarded as a thatch-roof risk.
If you have renovated your property, such as adding a room, creating green features or installing a generator, be sure to specify these improvements. Security must also be reviewed and checked against the policy terms. Be mindful that these requirements can change.
If your home is not sufficiently maintained, or the sum insured value is inaccurate, you could find any claims only proportionately paid out, or repudiated altogether. Under-insurance would be the worst-case scenario, so make sure you have factored in everything to mitigate this risk.
ACTIVE VERSUS PASSIVE: WHAT SHOULD I GO FOR?
How do I choose between active and passive portfolio management? I assume there are pros and cons to both.
Jaanre Muller, a wealth manager at PSG Wealth in Hermanus, responds: It is important to understand the difference between active and passive investing before deciding on a strategy. Active managers believe they can outperform the market through their superior investment insights. Passive managers believe that active managers cannot consistently outperform their benchmarks, and therefore opt for a strategy of replicating a specific index or benchmark. It is often referred to as index investing.
Most passive managers argue that markets are efficient and the chances of selecting active managers that will outperform the market are slim. Furthermore, active investing requires the specialised skills of professionals, which can be perceived as expensive compared with passive investing. By contrast, passive investing is deemed to be simple and more cost-effective. However, this is not necessarily the case. It takes a significant amount of research on what you are tracking, what the possible investment outcomes may be, and the associated risks and costs.
Ultimately, it’s important to understand your portfolio’s asset allocation, what your passive fund is tracking and the associated risks. As with actively managed investments, it is necessary to consider your financial goals and objectives when deciding on your investment strategy.
A considerable proportion of active managers cannot outperform the market. However, there are some who are able to outperform their benchmarks consistently, so it is important to do adequate research into potential fund managers and their track record.
It is important to have a solid knowledge of active managers and the strategies they employ to beat their benchmarks. Although an investor may have to pay a management fee for the fund manager’s insight, it may be worth it over the long term.
Furthermore, an active manager can provide valuable guidance in a complex market environment, ensuring that you stick to your long-term financial plan, avoiding making the wrong decisions when markets become turbulent.
The biggest argument for active investing is that it plays a critical role in determining the true or fair value of an underlying asset, and so it is critical in keeping markets efficient. A good active manager would be able to benefit from a mispricing of assets in the market.
It’s important to remember that active and passive management are not mutually exclusive. In certain instances, it makes sense to consider the use of a cost-effective passive alternative, such as tracking the performance of a specific sector of the market in a rapidly changing environment or where the portfolio is not big enough to attain sufficient diversification.