• How to Grow your Wealth Through Investments
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How to Grow your Wealth Through Investments

27 September 2016

By Peter Harten, Certified Financial Planner at BDO Wealth Advisers

In the modern world of investments, great emphasis is placed on transparency of investment platforms, investment structures, investment managers and advisers.

To put these different parties into perspective, it’s useful to consider the following analogy.

The investment platforms, or institutions providing the administrative capacity to implement and report on investments, e.g. insurers like Momentum and investment managers like Allan Gray, should be viewed as the “Garage”. The investments or legal structures, e.g. Unit Trusts or Endowments, can be viewed as the “Vehicles”, housed within the “Garage”. These vehicles are in turn powered by “Engines”, or Portfolios, managed by the investment managers. The Adviser, or Financial Planner, is the person who recommends what Garage stores what Vehicle and what Engine is used to power the Vehicle. All of these elements have different cost structures and capabilities.Investment Engines use Asset classes which can be divided into Cash, Bonds, Property and Shares. These assets can be in South Africa or abroad. Each asset class has different return and risk profiles which are determined from actual performances and volatility actually achieved and experienced over very long periods of time.

Cash

Cash is regarded as the least volatile asset class and has provided a return of 7% per annum in SA over the last ten years. The returns that you get from a cash investment is in the form of interest, which is fully taxable. Investors in South Africa get an interest exemption, of R23,840 for people under age 65 and R34,500 for people over the age of 65. This means that interest received up to this exemption amount is free of tax. Thereafter, the interest income is added to your other income and taxed at your marginal rate of tax. This makes interest a relatively unattractive investment return. If your marginal tax rate is 41%, it means that a gross interest of 7.5% will yield an after-tax return of only 4.43%. Investors do like cash as an investment because the amount invested is ‘safe’ and is only at risk in the unlikely event of a bank collapse.

Bonds

Bonds are long term loans issued by Governments or big companies. The loans are secured by the assets of the Governments or companies which issue the bonds. They contain an interest rate stated on a bond, called the coupon, which may be flat or linked to inflation. Bonds issued by big companies are regarded as riskier than the bonds issued by Governments, because companies are more likely to fail than Governments.

The market value of bonds does fluctuate relative to the level of interest rates in the market. If market interest rates go up the value of bonds goes down and vice versa. Therefore, bonds provide two types of investment returns, being interest and capital gains/losses. Also, if the issuer is perceived to be or become riskier, bonds will lose value. The interest received on your bond investments is treated in the same way interest from cash is, while the increase or reduction in market value of your bond is treated as a capital gain or capital loss and taxed accordingly. Bonds have provided a gross return in SA of 8.3% per annum over the last 10 years.

Property

These investments provide returns in the way of rentals and capital gains or losses. Capital gains and losses are achieved when the underlying property investments go up or down in value. It is only wealthy investors who can afford to invest directly in properties. Retail investors invest in properties through Real Estate Investment Trusts (REITS), where they invest in units in an underlying portfolio of properties.

Rentals received from your property investments are taxed as income while increases or decreases in the underlying capital values of properties will be treated as capital gains or capital losses and taxed accordingly. The relative attractiveness of property investments is determined by a multitude of factors from political stability to business activity and many other considerations. Property investments experience prolonged cycles of growth or stagnation. These investments have provided returns of 17.3% per annum, in SA before tax, over the last 10 years.

Shares

The final asset class is Equities or Shares in companies which are listed on the Johannesburg Stock Exchange in South Africa and various exchanges worldwide. These are actually investments in companies involved in a range of activities. Like properties, generally only wealthy investors invest directly in shares. For the rest of us, we invest via retail investment portfolios or Unit Trusts. This asset class is perceived to be the most volatile or risky with the biggest potential for high returns. Being a volatile investment class, one can expect a range of good and bad investment returns determined by economic cycles and the underlying activities of the companies whose shares you are invested in. South African Equity investments have provided average returns of 13.7% per annum over the last 10 years. These returns are a mixture of capital growth and dividends. Dividends are subject to Dividends Withholding Tax of 15% and your capital growth is taxed at a lower rate than normal income.

So far, we have only dealt with assets invested in South Africa. When you invest in assets outside South Africa you add a further dimension of diversity and exchange rate fluctuations. For example, when you invest in worldwide shares you have access to companies that are not available on the Johannesburg Stock Exchange, like Google. Worldwide cash provided average gross investment returns of 1.1% pa, over the last 10 years, worldwide bonds 4.2%, worldwide property 3.8% and worldwide equities 4.5% percent per annum, in US dollar terms. Over the same 10 year period our Rand depreciated at 6.9% per annum against the US dollar.

From the above description of the engines that are available to power your investment vehicles, it can be seen that not all vehicles in a particular garage will perform the same. Performance is dependent on the portfolio or engine selected and the mix of the various asset classes contained in your portfolio. If someone tells you that their Sanlam investment performed terribly, the first thing you should ask is what engine was powering their investment vehicle.

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