Where to invest if you’re young
The earlier you start saving, the more time you have to benefit from compound growth
Rob is a 22-year-old who recently finished studying and has started his first job.
Since the age of 16 he has saved money from part-time jobs and side businesses and made some astute investment decisions.
As a result he has saved up R360 000 and bought his car with cash. (See “How to build wealth from your holiday job” on Page 11.)
Most of his money is invested in equities through unit trusts and his own share portfolio, but now he wants advice on what the next step should be.
Is it time to invest in property? What about increasing his retirement savings?
“I have R65 000 saved in a money market account and I want to know whether I should use this money to put down a deposit on a property or to continue with my share investments,” says Rob.
In addition, he has about R4 000 a month that he is able to invest and he contributes 10% of his salary to his company’s provident fund. He also wants to know whether he should take out a retirement annuity.
“Rob is the classic example of a Warren Buffet-type student who is optimising the compound effect of growth,” says Derick Ferreira, national marketing manager at Old Mutual.
The key to Rob’s success is that he started saving young and has therefore benefited from the growth of his investments.
Of the R360 000 he now has, only about R140 000 came from actual savings – the rest is from pure growth from his investments.
If he had spent that R140 000 on a flashy lifestyle he would have little to show for it, yet today it has grown to R360 000.
Rob’s financial success has also been a result of the fact that he saved in a growth asset – namely equities.
If he had just invested in cash earning between 5% and 6% then his return would have been much lower.
If Rob never saved another cent but simply continued to invest his current lump sum in a growth investment that delivered an undemanding 10% a year, he would have R2.6 million by the time he is in his 40s.
“People always ask: ‘Where should I invest? Who is the best asset manager?’ The key is to invest in time, because the sooner you start investing, the more you benefit from compound growth,” says Ferreira, who says consumers often confuse “wants” and “needs”.
“A person may want a big house and a fancy car, but what they really need is transport and a roof over their head,” says Ferreira.
Rob chose to live what he called “a spartan lifestyle”. Although it meets his needs, he has postponed his wants in order to build capital.
“Once you have excess money and you want to spoil yourself, you are in a position to do so, as long as you have the means,” says Ferreira.
Rob has done all the right things but has reached a stage where he needs individual, expert advice.
“Now would be a good time to sit down with an accredited financial adviser and do a proper financial analysis,” says Ferreira.
Although Rob is clearly an astute investor, a financial adviser can provide a sounding board for his investment ideas and help him to assess what his goals are for the next five to 10 years.
Having a clear idea of where you are and where you are headed helps to inform your investment decisions.
Investing in property
Ferreira says that although debt for consumption is “bad debt”, there is also “good debt” and that is when you invest in something that can grow, such as property.
Most people want, at some stage of their lives, to own a home.
Few are able to buy it with cash, so debt is necessary.
Investing in a retirement annuity
In terms of a retirement annuity, Rob should first ensure that he is contributing to the maximum level in his provident fund.
Company retirement funds tend to have lower fees than a retirement annuity.
But Ferreira says Rob must ensure that he is maximising his tax benefits by contributing the maximum amount into a retirement annuity that is allowed as a tax deduction.
Underlying investments in retirement annuities are also exempt from capital gains tax and dividend tax.
It is estimated that this tax saving boosts the final return by about 10%.
Rob can invest about R1?750 a year or 15% of all non-retirement funding income into a retirement annuity.
This means 15% of all income that is not used to calculate his current 10% provident contribution, which would include non-pensionable bonuses and any other source of income outside his salary.
Ferreira says Rob should calculate his tax-effective contribution at the end of the tax year each February and make the payment into a retirement annuity.
He would then qualify for a tax rebate, which Rob could use to invest in discretionary savings such as unit trusts or his own share portfolio.
If Rob uses the tax rebate to go on a shopping spree, he negates the tax benefits for saving purposes.
As long as you are able to afford the repayments, debt for property is not a bad thing.
Rob is specifically looking at property as an investment in order to rent it out.
Ferreira says buying a property at this stage could be a good diversification as it exposes him to another asset class.
In terms of using the money market funds as a deposit, Ferreira says one just needs to look at the relative returns of a money market fund versus paying off a bond.
At best Rob would receive about 5.5% on his money market fund and some of the interest could be taxable, depending on the total interest earned in the tax year.
On a mortgage Rob will pay about 9% in interest, so by using the money market funds as a deposit he is in fact creating a risk-free “return” of 9%.
Fund managers believe the equity market is currently overvalued, whereas residential property prices are relatively weak and estate agents refer to property as a “buyer’s market”.
This means Rob may find more investment opportunities in buying property with his R65?000 than investing it in South African shares.