The words saving and investing have different rings to them they both have a place in your wealth creation journey. Saving should be more short-term, around 3 years or less, for things like planned future purchases or emergencies. You should have funds saved up before diving into investing.
Many people find out the hard way by thinking they are saving when they are really investing. Investing involves buying assets such as shares, bonds, unit trusts or real estate. The value of these assets fluctuates – meaning they can rise or drop significantly. On the other hand, savings products maintain their value and the money you’ve invested isn’t usually at risk.
Living in reality
Unfortunately, in order to earn higher returns over the long-term and grow your wealth exponentially, you have to invest in a portfolio of assets – not just save your whole life. This portfolio needs to be diversified and not contain a lot of the same or similar assets.
We should aim to purchase a number of unit trusts which are off-the-shelf diversified asset portfolios offered by reputable financial institutions. However, if you are experienced enough, have the time to research, have a background in investing and understand what you are doing, opening a self-directed investment account could be also an option.
Any other options?
A Tax-Free Savings Account (TFSA) could be the answer you’re looking for. A TFSA should be viewed as a long-term investing vehicle. These investments are already diversified, with some giving you global exposure or exposure to a specific asset class like real estate or mining companies.
You can either purchase a combination of unit trusts from a TFSA provider or purchase Exchange-traded funds (ETF). ETF’s can be traded just like shares in a listed company and they have the diversification benefits of unit trusts, often at a lower cost – you can find a list of all the ones available in SA here.
Essentially, an ETF is a fund made up of a number of similar assets. The assets in the fund are passively chosen and aren’t actively picked like in most unit trusts. This is one of the reasons why they are more affordable.
Remember, costs can be controlled, but returns can’t, so focus on buying funds with the lowest fees expressed by the TER – Total Expense Ratio. The TER of each fund is available on all Minimum Disclosure Documents. A good way to see this is to use the T-Rex score to visualize the negative effect costs have on your investment.
Benefits and flexibility
Arguably the best benefit is that all proceeds earned from an investment in a TFSA – including interest income, capital gains and dividends, are exempt from tax. This means that you keep even more of your returns. They also provide contribution flexibility, allowing investors to stop and start their contributions at will.
You can use your TFSA to invest in Exchange Traded Funds (ETFs), with up to R36,000 a year, and a total of R500,000 over your lifetime. You can withdraw funds but you won’t be allowed to replace the amount withdrawn. This encourages investing for the long-term – the way it should be.
With time on your side, reduced tax, lower costs and the ability to buy diversified ETFs which have global exposure, the National Treasury deserves a thank you for allowing South Africans to make use of the TFSA.