MANY investors make the mistake of not taking some degree of risk by investing in growth-orientated assets. They tie themselves into too short-term time horizons. With volatility in markets, a sensible time frame for investing in equities should be in excess of five years.
Many investors think in the short term because they are uncertain of the exact direction they should take. They also believe that they need to have access to their capital. Thus, the security of capital is paramount and they would rather go without, than touch their investment. For this reason, the wrong initial decision may be made at the start of the investment because the investor is focussing on sentiment rather than on a sound strategic reason.
If the need is for higher income, then security and certainty are essential and equities might not provide the answer.
The question is: "Does a fixed deposit or money market investment give the investor the answer?"
"Yes" to security. "No" to certainty!
The reason is that rates fluctuate and after allowing for the tax-free entitlement, taxes have to be paid.
The investor needs to calculate the after-tax return rather than focus on the gross interest from an investment. Using a 6 percent, before tax, return in the table below, I have illustrated the nett return after tax.
- Investment income per annum of R200000. Tax rate 25 percent. Net return 4,5 percent;
- Investment income per annum of R300000. Tax rate 30 percent. Net return 4,2 percent;
- Investment income per annum of R400 000. Tax rate 35 percent. Net return 3,9 percent;
- Investment income per annum of R580000. Tax rate 40 percent. Net return 3,6 percent.
From these figures you'll notice that as you earn more, the after-tax return reduces substantially. Consider that equities are currently paying approximate dividends of 2,7percent tax free, with the added long-term advantage of growth, whereas fixed interest investments are affected by inflation with no chance for growth.
It makes no sense for high earners to be invested in fixed interest investments, particularly if they have a long-term investment time horizon.
Remember "The Rule of 72"?
By dividing the number 72 by the rate of inflation, you can calculate the number of years in which the rand will halve. At inflation rate of 7,2 percent (72 divided by 7,2 = 10), R1000 worth of income in 10 years will only have a buying power of R500.
Returning to my original point about short-term horizons, investors who do not need to use their capital, but who are fearful of taking risk, repeatedly make decisions for six to 12 month periods, driven by the concern that they may need instant cash.
Making the same short-term decision six times is actually equivalent to making a single long-term decision for five to seven years.
Makes you think, doesn't it? If this is the scenario, the investor should be thinking very differently at the outset.
Let me underscore this with the expression: "How time flies!" In December, we all ask "Where has the year gone?" And, if you think back to the clearly remembered events from the past year, investing for a longer period will not seem so long after all.
The writer is a financial adviser of Bryan Hirsch Colley and Associates. Email bryanh@bhca.co.za
Longer term ventures score
MANY investors make the mistake of not taking some degree of risk by investing in growth-orientated assets. They tie themselves into too short-term time horizons. With volatility in markets, a sensible time frame for investing in equities should be in excess of five years.
Many investors think in the short term because they are uncertain of the exact direction they should take. They also believe that they need to have access to their capital. Thus, the security of capital is paramount and they would rather go without, than touch their investment. For this reason, the wrong initial decision may be made at the start of the investment because the investor is focussing on sentiment rather than on a sound strategic reason.
If the need is for higher income, then security and certainty are essential and equities might not provide the answer.
The question is: "Does a fixed deposit or money market investment give the investor the answer?"
"Yes" to security. "No" to certainty!
The reason is that rates fluctuate and after allowing for the tax-free entitlement, taxes have to be paid.
The investor needs to calculate the after-tax return rather than focus on the gross interest from an investment. Using a 6 percent, before tax, return in the table below, I have illustrated the nett return after tax.
From these figures you'll notice that as you earn more, the after-tax return reduces substantially. Consider that equities are currently paying approximate dividends of 2,7percent tax free, with the added long-term advantage of growth, whereas fixed interest investments are affected by inflation with no chance for growth.
It makes no sense for high earners to be invested in fixed interest investments, particularly if they have a long-term investment time horizon.
Remember "The Rule of 72"?
By dividing the number 72 by the rate of inflation, you can calculate the number of years in which the rand will halve. At inflation rate of 7,2 percent (72 divided by 7,2 = 10), R1000 worth of income in 10 years will only have a buying power of R500.
Returning to my original point about short-term horizons, investors who do not need to use their capital, but who are fearful of taking risk, repeatedly make decisions for six to 12 month periods, driven by the concern that they may need instant cash.
Making the same short-term decision six times is actually equivalent to making a single long-term decision for five to seven years.
Makes you think, doesn't it? If this is the scenario, the investor should be thinking very differently at the outset.
Let me underscore this with the expression: "How time flies!" In December, we all ask "Where has the year gone?" And, if you think back to the clearly remembered events from the past year, investing for a longer period will not seem so long after all.
The writer is a financial adviser of Bryan Hirsch Colley and Associates. Email bryanh@bhca.co.za
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