Monthly Archives: October 2016

The gift that keeps on giving

This time of year sees both children and adults preparing their wish-lists for the upcoming festive season. But as many South Africans continue to grapple with rising debt, now is a good time to shift the focus from giving material items to providing future financial well-being.

Giving a child an investment as a gift will not only promote a culture of saving from a young age, but will also show them how you can make money grow.

There’s a powerful story of one customer’s commitment to leave a legacy for his family, and the value of sound financial advice. In November 1968, a customer made an initial deposit of  R400 into the Old Mutual Investors’ Fund and 48 years later, his investment is today worth over R600 000.

More precious than the value of his money, however, was the culture of saving and the legacy that he passed on to his children and grandchildren. On special occasions such as Christmas and birthdays, he invested a set amount of money on his children’s or grandchildren’s behalf. With this investment, his daughter was able to provide for her daughter’s schooling.

If South Africa is to develop a generation of financially savvy adults, it is crucial to not just talk about it, but actually practise good money habits. It is important to teach your children about money, and the festive season – with the spirit of giving – is a good time of the year for parents to set a good example. Teach your children about the importance of giving within your means, as well as showing them the value of relaxing with family and rewinding after a long, hard year, while respecting the value of hard-earned money.

Families should consider starting a financial tradition of their own. Set a reasonable budget for gift giving this festive season, and instead of spending all your money on gifts that are likely to fade, go missing or be forgotten, speak to your financial adviser about starting an investment in the name of your children.

When children become old enough to understand more about money management, parents should involve them in the process. Teach them the principle of compound interest and explain why putting money away today means they will have more money tomorrow. Help them set a budget for the money they’ll receive over the festive season, encouraging them to spend a smaller percentage today, and investing the rest for the future

Options at retirement

Q: I will retire at the end of October 2016 from government service. I have the option of a retirement gratuity of R1.2 million plus a monthly pension of R 27 414 for life, or a resignation benefit of R5 047 648.

The downsides of taking the annuity option are that when I die the monthly pension that will go to my wife will halve; and that when she dies, the pension stops altogether and nothing will go to our children. I’m also worried by the current political landscape in South Africa whether I can have peace of mind with regard to how the GEPF will be managed in future.

My question is this: If I rather take the resignation benefit of R5 047 648, can I obtain a monthly income comparable to the monthly pension of R27 000 plus the yield on the investment of the R1.2 million gratuity through investing this amount?

The reader belongs to the Government Employees Pension Fund (GEPF), which is what is called a defined benefit fund. The retirement benefits are therefore defined with regard to the reader’s salary at retirement and the length of service at their employer.

Let us consider the two options that the reader has presented in more detail:

Receiving an annuity for life

The reader will receive an annuity, for life, which begins at R27 414 per month. On death, the spouse would continue to receive 50% of this annuity for the remainder of her life.

Pension increases are also usually granted annually by the GEPF in line with their policy which targets 100% of CPI. The reader is also entitled to a gratuity lump sum at retirement of R1.2 million.

Under this scenario, the GEPF, assumes the investment risk. In other words, the member will continue to receive their pension, irrespective of how the underlying investments perform.

The GEPF also assumes the longevity risk, or the risk of the member and their spouse living longer than expected. As an extreme example, if they both lived to 120 years, they will continue to receive their pension. On the other side of the coin though, if they both pass away shortly after retirement, no further payments will be made and any children dependants will not receive any lump sum payment.

Taking the lump sum and investing it

The reader states that they are entitled to R5 047 648 as a resignation benefit. For purposes of this comparison, the impact of tax on this amount has not been considered as this could vary by individual.

Let us assume that this money will be invested into a living annuity-type structure in order to provide a retirement pension. Under this scenario, the lump sum is invested and a pension is drawn from this balance for as long as the balance is positive.

To put it simply, this operates similar to a bank account. The account increases with investment returns and reduces by any amount that the reader withdraws in the form of a pension.

It is important to realise that the reader will be assuming both the investment and longevity risk under this scenario. Poor investment performance will impact on the amount of pension that the reader may be able to withdraw. Additionally, if the capital is fully eroded while the reader is alive, no further pension will be payable. However, on death, the balance of the account can be paid out to the spouse or other dependants.

Invest or put money into your bond

In this advice column Alexi Coutsoudis from PSG Wealth answers a question from a reader who wants to know what to do with a lump sum investment.

Q: I have R100 000 in a unit trust. At the same time I have an outstanding bond. Would it be better to remove the funds from the Investment and offset part of the home loan?

Advisors are frequently asked this question. This often has more to do with personal risk preference than with economic rationality. To answer this question, however, certain assumptions must be made, and I specifically won’t look at tax to keep the answer succinct.

The rational answer

Let us assume that the interest rate on the bond is at the prime lending rate. That is currently 10.50%

The second assumption we need to make is about what the risk level of the unit trust in question is. A money market unit trust has a very different risk and associated return goal than an equity unit trust.

A low-risk money market or income fund aims to beat inflation and offer a real return of 1% per annum. Thus, if the R100 000 is in an income unit trust only yielding 7% to 8%, it would be rational to secure the higher guaranteed return of 10.5% and transfer the funds into the bond.

However, if the money is in a balanced fund which generally targets a 5% real return, it would be more rational to remain invested as the real return is in excess of the bond interest rate.

It is also important not to fall into the trap of looking at the short-term underperformance of equity linked funds in a time like now and compare this to a resilient prime rate. This may result in the wrong decision to sell out at the wrong time. Every situation is unique and the best course of action is to get advice from a financial advisor who will look at the big picture and your individual circumstances.

The subjective answer

The other way I would advise a client on this is a more subjective approach – the sleep test. Quite simply, what makes you sleep better at night? Would that be a bond balance of R100 000 lower than it is now with no funds invested, or the same outstanding bond balance but R100 000 invested?

The answer will be different for each individual and there are a lot of factors that influence one’s financial decision making such as your view of debt as either toxic or as an enabler. For some people having R100 000 invested offshore, for example, gives them comfort. Therefore, because the economic rationality argument is often such a close contest, considering the subjective approach may help make the final decision easier.

Withdraw your retirement benefit

Q: I am 39 years old and have worked for the public service for just over 11 years. I am considering resigning because I want to further my studies for the next three years.

My current retirement fund value is R947 113.

How much will they tax me if I take this out and how best can I invest it?

The short answer to your question is that you will be paying R191 820.51 tax on a retirement fund value of R947 113. In other words, 20.25% of your retirement benefit will be paid to the South African Revenue Service (Sars).

How this is calculated is that your capital will be taxed on a sliding scale. The first R25 000 is tax free, the next R635 000 will be taxed at 18% and the balance will be taxed at 27%. Although not relevant in this instance, any amount over R990 000 would be taxed at 36%.

However, you can avoid this tax entirely by transferring the benefit to a preservation fund. This is an option you should seriously consider.

A preservation fund works in the same way as a retirement fund, except that you don’t have to keep contributing to it. You will be able to make one withdrawal from this fund before your retirement date, but otherwise you won’t be able to access the money until you turn 55.

Once you retire from the fund, the first R500 000, less any amount you have already withdrawn, will be paid out tax free. At this point you can withdraw up to one third of the capital as a lump sum if you like, but the rest must be used to arrange a monthly income during retirement. You will be taxed on your monthly income according to Sars income tax tables.

Why this is particularly important is because if you withdraw your retirement capital now, the R500 000 tax-free benefit that you would receive when you actually retire will fall away. So you will be suffering a double tax penalty.

Apart from the tax you will have to pay now, you should also consider the important differences between putting the money into a preservation fund and taking it out to invest yourself.

Applications affect on your credit score

There is a view among many South African consumers that applying for a bond at more than one bank will have negative consequences. The belief is that these enquiries will impact on your credit score and therefore hurt your chances of getting a loan or push up its cost if you are successful.

Many people only apply at their own bank for just this reason. They think that they are taking a risk if they shop around.

This raises some obvious concerns. After all, you are only exercising your rights as a consumer to compare prices, so why should you be penalised for it?

Footprinting

What is a given is that every time you apply for a loan of any sort, this will be recorded on your credit profile. This is called footprinting, and credit providers may use this information to assess you.

“Credit providers consider a multitude of factors when vetting applications for credit, one of which would be demand for certain types of credit,” explains David Coleman, the head of analytics at Experian South Africa. “A sudden surge in demand for unsecured or short term credit, linked with signs of stress building on indebtedness and repayment capacity of the consumer, would result in the credit provider taking a more cautious approach in extending further credit to such a consumer.”

However, short term credit is not the same as long term credit like a home loan in this regard. In fact, Nedbank says that it views multiple applications for a bond made at the same time as a single enquiry.

The head of credit for FNB retail, Hannalie Crous explains that they also make a distinction:

“From an FNB perspective we do not look at number of bureau enquiries pertaining to home loans as a key determinant of a credit score,” she says. “The handful of credit bureau enquires associated with a bond application will have no effect, however  a consistent trend indicating that a consumer is taking on multiple loans could influence the outcome of a credit application.”

Not all bureaus will see you the same

In other words, the banks don’t see it as a negative if you shop around for a bond. A number of credit bureaus approached by Moneyweb also took the same line, although with a caveat:

“Each credit bureau and each credit provider that has their own in-house score will score consumers using their own criteria,” says Michelle Dickens, the MD of TPN. “It’s not a one size fits all. As a result there will be a higher weighting towards different aspects of data that will improve or decline the ultimate overall score.”

The head of the consumer bureau at XDS, Alex Moir, explains that different companies may therefore use information differently.

“Not all credit bureaus will use the application data in the credit scores, which means that a customer could go to as many banks as they like and their risk score with these bureaus would not be impacted,” he says. “Some credit bureaus do however use the application data and, in this instance, the consumer’s score could actually be impacted positively if they do enquiries at different banks. There is generally a threshold that some of the bureaus would have, where making one to three enquiries would add points to your score, three to five enquiries would leave the score as is and more than five could deduct points from your score.”

Moir adds that he believes this is a legacy from when these scorecards were developed and there was not much data available. Therefore any data that was supplied got used. However, this should now be the exception.

“Where you have a consumer with a lot of information such as a number of accounts with payment profiles, there’s enough other data to make an assessment,” says Dickens. “But when there is not a lot of other information, then the weighting could lean more towards the footprinting.”

She adds, however, that what bureaus can’t do is give you a bad score just because they have nothing to go on.

“One of the things the scores can’t do is

Old Mutual Investment Group

Old Mutual Investment Group sees domestic equities, property and bonds delivering higher returns in 2017, on the back of improving economic prospects.

It expects peaking interest rates and inflation in South Africa to create a positive environment for interest rate sensitive assets such as domestic property and bonds.  It sees inflation averaging at 5.4% in 2017 compared with 6.3% in 2016 and the benchmark repurchase rates falling to 6.5% by the end of 2017, down from 7% currently.

According to Peter Brooke, head of Old Mutual Investment Group’s MacroSolutions Boutique the 13.5% return on domestic bonds year-to-date as at November 24 2016 is artificially high due to an oversold bond market.

Instead, he said SA cash – with a 6.8% return in rand terms – is the best performing local asset class thus far. SA listed property delivered returns of 4% and the FTSE-JSE Share Weighted Index (SWIX) returned 2.5% over the same period.

After starting the year with the highest level of cash in its fund ever, the group is seeing more opportunities in equities as the domestic equity market de-rates.

“We’re not at the stage where the JSE is cheap yet. It is on a 13x forward but it does offer a real return in the region of 5%. We’re not back to levels that we have enjoyed for the last 100 years of around 6.5% but value is starting to incrementally rebuild,” he said.

As a result, the group upped its long term expected real returns on SA equities from 4.5% to 5% and SA property from 5% to 5.5%.

“When we look at a balanced portfolio and we just use our static benchmark, in other words a passive offering, the expected real return on a balanced fund has picked up to 4%. It is the first time it has been at the 4% level in two and a half years, so we are starting to see a little bit of a better return coming through,” he said.

The group also warned against “excessive pessimism” over the South African economy as its prospects start to look up.

“Load shedding is long past, commodity prices have stabilised and have actually recovered a bit, rainfall is improving, the food inflation shock will reverse in the months to come and the labour environment has stabilised notably this year,” said Rian le Roux, chief economist at Old Mutual Investment Group.

He added that the National Treasury’s commitment to fiscal consolidation is expected to reduce pressure on monetary policy and lead to a lower interest rate from mid-2017.

The group has forecast GDP growth of 1.3% for 2017 but warned that improvements are likely to be slow due to the strained consumer environment, depressed business confidence, low levels of private investment and an expected rise in taxes.

Still, the expected improvement in global economic growth is likely to provide some support. However, a potential break-up of the Eurozone, a hard landing in China, aggressive interest rate hikes in the United States and domestic political uncertainty remain risks.

The unemployable become employable

Luthuli Capital was founded and structured as a Pan-African multi specialist company that offers a global approach to wealth management portfolios. The company offers investment advisory services to local and foreign individuals and multinationals, among others. I’m joined in the studio by one of the co-founders, Mduduzi Luthuli. Thank you so much for your time.

MDUDUZI LUTHULI:  Thank you for the invitation. Glad to be here.

NASTASSIA ARENDSE:  Let’s take it back to the beginning and start off with how Luthuli Capital came together.

MDUDUZI LUTHULI:  I think if you are going to start a company it’s always something that’s there. It’s just a matter of acquiring the skills for you to be confident to run the company and wait for the circumstances to be there.

I’ve been in the corporate sector now – from banking into the financial advisory industry – for about seven years. My previous employer gave me a great opportunity in management and it’s really there where I got to cut my teeth and get to the point where I realised I think it’s time for me to go out there and do this on my own.

We’ve got two offices here in Sandton and one in Durban. It really was the Durban office that was also the big motivator because we’ve got a project going on down there which involves the internship, and that also just got to that point where, if ever you are going to do this, this is the time.

NASTASSIA ARENDSE:  And I know that you work with Trudy as well. How did the two of you decide that it’s our synergies and both our characteristics and everything we’ve learned from our own sort of corporate size that can work together – and let’s do this?

MDUDUZI LUTHULI:  We both come from the same industry. So from a product knowledge side, services, the competency was there. I think really where the synergy comes from is they say I’m the driving force, I’m the bully, I’m the hard-core one. My real talent is bringing the clients into the business, going out there and selling the dream and convincing them that this is something you should back.

And Trudy, as head of client services, is the mother of the business, if I can put it that way. And really her strength is in client retention. You play a fine balance between finding new clients and also looking after your existing clients. And that’s really where we work with each other’s strengths and work very well together, because she heads up the client retention. I bring them and she looks after them.

NASTASSIA ARENDSE:  How competitive is the industry that you are in right now?

MDUDUZI LUTHULI:  It’s extremely competitive. I don’t think I have the words to truly describe how competitive an industry it is. One of the fantastic things and one of the shining lights about South Africa is that we have a very good financial system. Or let me say that the governance and the legislation here is very good and that really translates into the financial advisory system with the initiatives that the FSB puts out there – the financial planning institution, to make sure that as financial advisors or wealth managers we move away from a culture of just selling for the sake of selling, and seeing ourselves and conducting ourselves as professionals and as a professional field.

So now you are working in an industry where you have exceptional professionals, people giving advice. And really you have to convince the client as to say why you. And I would even say you have very established players, your Allan Gray, your Stanlibs of the world, your Old Mutual, your Liberty. So as a new company going after clients and acquiring big clients, there’s already someone existing there, giving them advice; there is really an existing relationship. Now you have to convince them to say: what am I bringing to the party that will convince them? It’s very competitive.