Question:
My children (aged 16 and 18) want to start a savings/investment account. They wish to invest a R3000 lump sum and R200 per month.

What are the best products for the medium term?

Answer:
Before deciding on any investment vehicle or strategy, the first question anyone should ask is 'what is this money destined for?' and, more importantly, 'what kind of returns do I need it to achieve for me'.

The first question usually determines whether the money should be treated as savings or as an investment. Savings usually suggest that the funds will be used in the shorter term and therefore require a low cost vehicle with little or no risk associated with it. Typical vehicles that would be suitable would be provided by the bank in the form of call accounts, money market accounts or even fixed deposits. These savings vehicles are not exposed to the equity market in any way and gain their returns from interest accrued in accordance with the prevailing interest rates.

If we were to look toward investing for the medium term (assume three to five years) then a new world opens to a potential investor. With the first question answered, the next consideration would be to ascertain the kind of return you would need to achieve in order to realise your investment objectives. This return would then need to be matched with a suitable asset allocation in your chosen fund. Bearing in mind that we are dealing with the medium term, the rule of thumb would be to remain conservative in your strategy as volatile markets could seriously hamper the investment returns over such a period.

As a principle, only now does the question of what product or vehicle become important. Besides the banking products mentioned for savings there are essentially two areas that one could invest discretionary money namely: unit trusts (also known as Collective Investment Schemes) or endowments.

Regardless of whether investing through an endowment or unit trust, access to funds and exposure to different asset classes are essentially the same. However, the key differentiators lie in the liquidity and taxation treatment of these two vehicles.

Endowments are governed by the Long-Term Insurance Act and are therefore taxed by what is known as the 'four-fund approach'. What this means for an individual investor is that all net rental income (if there is property in the portfolio) and interest (accrued from fixed instruments) will be taxed at a flat rate of 30 percent. This then means that all capital gains will attract capital gains tax at a rate of 7.5 percent. This tax is paid within the fund and on behalf of the investor. The result is that the proceeds will be free of any tax purely because it has already been paid within the fund. As far as liquidity goes, you may have only two access points to your accumulated balance in the first five years by means of one loan and one partial surrender. In addition to this, the amount available is limited to premiums plus five percent compounded. Simply put, whatever your fund has performed in excess of five percent will remain in the fund until the end of the fifth year.

When comparing this to unit trusts (Collective Investment Schemes) and considering your stated needs, we see a far more favourable tax and liquidity treatment. These investments are governed by the Collective Investment Schemes Act and all taxation is dealt with in the hands of the investor.

What this means is that all interest and capital gains accrue directly to the investor. Therefore, if your marginal tax rate is under 30 percent, it becomes a 'no-brainer' as you will undoubtedly be in a better tax position. What is more, SARS allows for certain exemptions when it comes to interest and capital gains. For the tax year 2009/2010, the first R21 000 (under 65’s) or R30 000 (over 65’s) earned in interest is exempt from income tax. Similarly, capital gains up to R17 500 per annum are also exempt, however, it must be noted that a deemed disposal (selling/switching of units) must have taken place to benefit from this. Furthermore, there are no restrictions from a liquidity point of view and you can have full access to the funds from day one.

With this in mind, should the decision point to investing the money as opposed to saving it in the bank then a suitable unit trust would be the likely vehicle of choice. Although many mainstream unit trusts have a minimum premium of R500 per month, there are institutions that have unit trusts available from R150 per month.

With the vehicle consideration under wraps, you would be wise to seek the professional opinion of a Certified Financial Planner to guide you through the selection of a suitable fund that possesses the appropriate asset allocation and strategy to suit your desired investment objectives.

Good luck.

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