It aint over till its over

I cant help but think that with the markets having run as hard as they have since their lows in November last year and March this year (JSE is up >34% since then) that either we have been duped into believing there was a huge crisis which never actually existed and have now missed the best buying opportunity (perhaps ever), or else, the crisis is not over, the issues have not suddenly gone away and things have not returned to normal as we knew it. As a result there is probably still quite a bit of volatility lurking about…if you are investing money, be careful…

At this stage I would be inclined to phase funds in over the next ±3-6 months to try to iron out some of the potential volatility that is still lurking. I don’t think it is over yet…

So take a step back from all the noise around you (in the form of the daily newspapers, websites and TV shows) and get a little perspective. Also give some serious thought to investing funds offshore – developed markets are still offering reasonable value and the rand is still strong (remember we were at R14/$ at and R20/£ at one stage).

Thats’ all for now

The real cost of the bond…

I read with interest the comments from “experts” telling people to resist yesterday’s interest rate by not reducing their bond repayments. This makes a lot of financial sense but the comments from readers of the article clearly shows just how cash-strapped many people are and for many, even this cut will not be sufficient. (Although this is difficult to understand given that we are almost back to where we were just before rates started climbing). Clearly there is a lot of emotion out there…

One of the biggest issues around bonds is that most people have no idea of the time-value of money and as a result have no idea of the total cost of their house over the 20 year period. The table below shows the repayments and total cost on a bond over the full term as well as what the required payment would be if someone wanted to pay their bond off over 15, 10 or 5 years. It also shows the subsequent saving in interest as a result of paying it off more quickly. R1 million bond over various periods @11% interest

Period      Payment/Mnth   Ttl repayments*       Difference                Saving
20 years     R 10 322              R 2 477 252
15 years     R 11 367              R 2 045 621              R 1 045            R 431 631
10 years     R 13 772              R 1 653 306              R 3 450            R 823 946
5 years       R 21 747              R 1 304 457              R 11 425          R 1 172 795

*this is the total cost of the R1 million bond over the period.

What most people fail to realise is that if they just leave their repayment where it is before yesterday’s cut, they will pay the bond off in just over 16 years and as a result will pay +/-R321000 less in interest. It also makes sense to build in an annual increase in your bond repayment – in much the same way that you have annual increases in your pension, RA or life policy contributions – by putting an annual escalation of 10% on the repayment you would pay your bond off in under 10 years at current interest rate levels and would save more than R825000 in interest!

Remember too, not to let the bank take the premium for the home owners insurance off your bond – you end up paying interest on this amount for the full term of the bond as a result (read the blog It’s so easy to save money!) for more on this.

Just because it is raining it does not mean the drought is over!

One of the things I enjoy doing is collecting rainfall figures…I have been doing this for over 9 years and have built up a bit of a data base. I know this has nothing to do with financial planning but it is probably a legacy from my student days when meteorology was one of the subjects I studied.

Earlier on this year, I posted a blog called “Will it ever rain again in Cape Town ?” This was during one of the driest starts to the year that we have had in Cape Town in at least the last 9 years and also during a time when it seemed that most of the Cape-fold Mountains were on fire. The just of the post was that as sure as winter follows autumn, it will rain again – even if it did not seem likely at the time. I reasoned that in the same way, the equity markets would recover – that’s what they are designed to do – and that it was not the death of equities as we know it.

Anyone who was sitting in cash and trying to time the market was in danger of missing out on its recovery. Sure enough, both “forecasts” have happened – it is raining as I write this, and markets are up (significantly) from their lows. The problem now though, is that if you ask anyone about how much rain we have had, or about how dry it still is in Cape Town) most people will answer that there was never any doubt in their minds that it would rain again or that there is no way that this was the driest start to the year – after all, look at how much it is currently raining (it was still, however, the driest start to the year that I have recorded in 9 years).

This phenomenon is well explained by behavioural finance! People tend to place over emphasis on the current and as a result tend to forget the past. So anyone who thinks that because equity markets have run hard and recovered well from their lows, that all is over and that there is no volatility risk from investing in shares, they need to remember the past.

Equities are the most volatile asset class and there will still be (significant) periods of (significant) volatility ahead. If this is going to affect your income and/or sleeping patterns then perhaps you should not be in them to the extent that you are. Equity investing requires time – 25% in 6 months is a great return but this is not a significant period of time! The way to iron out the volatility is to diversify your assets and to give your equity portion time.

So watch out, there could still be some dry spells ahead. Just because it is raining it does not mean the drought is over!

Think before you swipe!

On the face of it, the Discovery Credit Card and Pick n Pay tie up is very attractive; pay for my Pick n Pay shopping with my Discovery Card and get cash back from Discovery every month (depending on my Vitality status of course). And it works – for the past year or 2 we have been getting back a few hundred rand each month. I know that Discovery and Pick n Pay have struck some sort of deal and I know that Discovery’s whole aim is to keep people healthy because this is cheaper than treating sick people…and for many people it appears to work, but when Discovery introduced the Healthy Food offering with promises of even more money back each month I started thinking about where “catch” is… after all, there are no free lunches and someone (probably me) is paying for this “free” benefit.

The answer, I think, lies not where you would expect it but rather in a very interesting bit of research that I discovered one day when reading about debt and credit cards. The research (from the USA ) is that people who buy day-to-day goods with a credit card are likely to spend 12-18% more than people who pay cash. More significantly, people who pay for food (and eating out) with a credit card will spend up to 54% more than those who pay for these expenses with cash. Seem unbelievable? Think about it! When you swipe your credit card, there is no emotional attachment to the purchase – you don’t feel it immediately. In fact, think back to the last time you swiped your card…what was the amount? I have amazed myself with this question. The number of times I have swiped my card, signed and walked away only to think a bit later “what was the amount”? Now imagine if you paid with cash and had to take R1500 out of your wallet (which you had to draw from the ATM)… I bet you would think a bit more carefully about whether or not you actually need everything that is in the trolley. Or think about the following scenario: you are on your way home from work and you need to pop in to buy bread and milk…but you don’t have any cash on you…so you use your credit card instead…but “bread and milk” is too little to put on a credit card so you pick up a magazine, some chocolate, chips and then you pay with the card…see how easy it is to spend up to 54% more? (In fact, the Healthy Food advert itself implies that people will end up buying much more than they need – think about the truck load of food that gets dumped on the lawn.)

I am not against credit cards (they have a place) but debit cards are a better bet (and safer than cash) – you cant spend money you dont have. I am also considering making June a “cash only” month and seeing if I actually end up spending less (I know it will be skewed because I will be more aware of what I am spending but isn’t that the point?)

Think before you swipe!

Financial Planning for Dummies – Part 2

The first article in the “financial planning for dummies” series identified the 5 most common risks people face, namely:

  1. Dying too soon and leaving debt or dependents.
  2. Living too long (insufficient funds on which to retire).
  3. Disability (over a short or extended period).
  4. Funds for short term emergencies.
  5. Debt!

This article looks at the first of these risks; Dying too soon!

The risk here is that of leaving debt and/or dependents with insufficient means to pay the debt or support themselves. Typical examples are that of a big home loan or a spouse with young children. In this case most people do not have sufficient assets or a wealthy family support network and opt to insure the risk. This means that they buy life insurance that will pay a pre-specified amount to their beneficiaries on their death. Life insurance is not an investment – it pays when you die! As such, it is my opinion that it should only be used to cover risks that you can not (or do not want to) take. No debt or dependents, sufficient cash/investment reserves, a big (wealthy) family support network or no estate duty problems and you probably don’t need any life cover.

How much is enough?

There is no right answer that applies to everyone and each situation is unique. R1 million might be more than sufficient for one person while R10 million may be too little for someone else. If the insurance is to provide for a spouse and dependents then it is reasonable to expect to be able to generate 5-6% as a sustainable (and increasing) income from the capital i.e. R1 million net could provide ±R50 000 to R60 000 (tax free) per annum.

Most people in formal employment and who belong to the company retirement fund will also most probably have some form of group life insurance. This is usually a multiple of the annual pensionable salary e.g. 3 or 4 times the persons pensionable salary and this needs to be factored into any calculations. Never ask an insurance salesperson if you need more life insurance – they are incentivized to sell insurance and it is highly unlikely that they would tell you that you don’t need any more cover. Rather, consult a financial planner for an informed opinion and be prepared to pay for the advice – it might cost a bit in the short term but could save you fortunes in the long run.

It is also essential to nominate (appoint) beneficiaries on all of your policies (and to make sure that any beneficiary nominations are still current) – not only does this avoid any confusion at your death, but it will also save you about 4% of the value of the policies. This is because while any proceeds from a policy still form part of your estate, those where beneficiaries have been nominated are not handled by the executors of the estate thus saving the executors fees on them.

Life insurance is also frequently used for business purposes. This is for things like Buy-and-Sell and Key Person policies where businesses need to ensure that there are sufficient funds at the death or disability of one or more of their key employees or in order to be able to replace them or to fulfill any contractual obligations that they may have.

Another frequent use of life insurance is to provide liquidity in an estate. Often when performing an estimate of the estate duty liability (effectively the amount of tax that will be paid by a deceased person’s estate) it is discovered that despite there being plenty of assets, there are no liquid assets which can be used to pay the estate duty. For instance an estate might consist solely of 3 properties which are being left to 3 dependents. This might mean that one or more of the properties would have to be sold in order to provide the liquidity to pay the estate duty. This is clearly unfair on one or more of the dependents and in these cases some people opt to take out life insurance in order to provide the liquidity in the estate at their death. If the life cover is to provide for estate duty liquidity then you will need to determine the quantum of the estate duty need in order to determine the amount of cover and you will also need to add ±25% of the value of the cover to compensate for extra estate duty on the cover.

Remember, financial planning is not only for the wealthy and super intelligent! Everyone should have a financial plan.

A financial plan should identify the potential impact of any of these areas (as well as any others) and should be designed to minimize its impact. It is about objective (measurable) advice that results in a plan to identify and manage current financial risks and achieve future financial needs and goals .

If you have concerns about your finances or financial positions, you should be speaking to your financial planner.

Proof’s in the pudding

Just a quick follow up on the post about Fundisa – I just received my transaction SMS from them…so far I have invested R1200 of my own money…the transaction statement reads as follows:

The balance at 04 May is R1,209.56 (investment) and R518.00 (grant). Nedgroup Investment…i.e. there is currently R1727 in the account that would be paid to a tertiary education institution…

Not too shabby!

Guaranteed returns of 25%?

There are few things that bug me more than seeing people being ripped off by insurance companies. I have just come across an advert for an education plan by one of the large SA insurance companies…for just R150 per month for 10 years…blah blah blah…stay far away from these policies – they are expensive and restrictive. As far as I am concerned people who want to save for their children’s education should first get rid of their debt and then they should make use of the Fundisa offering before considering anything else.

There is a unit trust offering with a guaranteed return of at least 25% so long as the funds are paid to an educational institution directly… This guarantee is from the government who are paying a 25% bonus to investors on a first-come-first-served basis (from a limited bonus pool – this is part of a pilot project) and on top of this there is the growth in the underlying fund.

So last year, I received a ±35% return on my investment…in these markets! Try and beat that! For the cynics out there, the “catches” are as follows: You can invest as much as you want but you only qualify for the bonus on the first R200 per learner. You can draw the funds out at any stage but will only get the bonus if the funds are paid to an educational institution directly (at this stage it has to be a tertiary institution).

They only communicate with you via SMS. There are no initial fees! You can substitute learners if you no longer need it for your kids. You can pay in as little as R40 per month. The underlying fund is a “boring’ income fund. In my opinion this is the best education offering in the country…only problem is that the take up has not been that great and I suspect that is largely because there is no incentive for advisors to sell it.

For more information and an application form go to www.fundisa.org.za

The great equity debate continues

All the while that this debate has been going on the market has risen…for anyone who invested at the low in Nov/Dec last year there has been a 22% return from the ALSI already…

I think there is a danger of throwing the baby out with the bath water here…equities are the most likely asset class to give you real returns over the long term…but they can be very volatile in the short term…and so the best way to think of them (in my opinion) is like the brilliant Heineken advert where the young techie “hikacks” the space probe and converts it into a bar counter with a Heineken on it…when asked “Now what?” He replies…”Now we wait…”

Same with equities…we invest and then we wait!

Financial Planning for Dummies – Part 3

The first article in the “financial planning for dummies” series identified the 5 most common risks people face, namely:

  1. Dying too soon and leaving debt or dependents.
  2. Living too long (insufficient funds on which to retire).
  3. Disability (over a short or extended period).
  4. Funds for short term emergencies.
  5. Debt!

This article looks at the second of these risks; Living too long – the risk here is that of outliving your funds.

From a financial planning point of view, one of the major risks that people face is living too long. This may seem an odd thing to tell someone in the prime of their life, but very few* South Africans will retire financially independent. In fact, by far the majority will be dependent on either the state or their families because they will have failed to make adequate provision (not a pleasant thought given that the state old age pension is currently ±R1010 per month).

Add to this the fact that the number of people living beyond 100 years is now doubling every 18 months and that children born in the 90’s and 2000’s have life expectancies in excess of 120 years** and it is possible that you could be retired significantly longer than you ever worked. So just how much will you need in order to retire financially independent?

There is little rocket science involved here. Remember the power of compounding; so the sooner you start saving for your retirement the better (even if it is in the very distant future). In order to determine the capital lump sum you will need at retirement you will need to determine your (equivalent) income at retirement. This is a simple future value calculation and is dependent on your current income and inflation over the period. The future income value will allow you to determine the capital required. The longer the period to retirement, the greater the effect of changing inflation and investment returns over the period so you should review these figures on a regular (annual) basis.

A seemingly insignificant 1% difference in the rate of inflation over a 20 year period can result in 22% more capital being required at retirement, while a 2% difference in the rate could mean a 49% increase in the capital required. An annual inflation rate of 6% (the upper limit of the current inflation target for SA) will mean that a current monthly income of R10000 will equate to just over R33000 in 20 years time. This will increase to just under R50000 per month if inflation is 8% per annum over the period (see table below). It is not difficult to see therefore, why every investor needs to outperform inflation.#
Current Monthly Income Needed          R10 000      R10 000     R10 000
Years until Retirement                          20              20             20
Assumed Inflation Rate % p/a                6%             8%           10%
Mnthly Inc Needed at Retirement        R33 102        R49 268      R73 281

The scope of this article does not allow for specifics, but assuming you were to retire in 20 years time on an income equivalent to R10000 pm today (8% inflation) you would require a capital lump sum in the region of R11.8 million rand to fund a monthly income equivalent to your current income need of R10000. (This depends on the type of annuity that is purchased of course.)

Cap Required (inc draw represents 5%)   R7 944 491   R11 824 327   R17 587 377

This is a lot of money so just how do you get there?

In South Africa, there are essentially 3 pre-retirement vehicles available; pension and provident funds for employees, and retirement annuities for the self employed and employees with non-retirement funding income such as commission. Apart from the obvious things like the tax incentives, retirement funds also have many associated legislative benefits which specify how and by whom the funds may be used. Chances are that if you work for a company that you belong to the pension/provident fund. If this is the case then unless you are a commission earner you will have a very limited ability to use a retirement annuity from a tax efficiency point of view and you should consider other investment vehicles such as unit trusts and exchange traded funds to supplement your investments.

So how do you go about planning for your retirement?

For starters you need a financial plan. Financial planning is a process and not an event and your plan should be reviewed annually (at least). While financial planning is not as complicated as some would have us believe and many people have successfully planned for their retirement themselves, there are definite advantages to working with a financial planner. Just be sure that you are working with a financial planner that is not just dependent on selling products to you but who can provide you with objective (independent) advice for which you should be prepared to pay if necessary.

One of the mistakes many people make is that they assume their income requirements will decline significantly in their retirement years. The evidence suggests that the opposite is in fact true and a good financial planner should be able to help you identify as well as quantify what your expenses are likely to be. Many advisors/planners are using complex models – make sure that you understand the output and ask questions about anything you don’t understand.

The planner should also be able to advise you as to the appropriate asset allocation (split between the various asset classes) given your time frame and your required rate of return and should also serve as your coach when you are tempted to make those emotional decisions like moving everything into cash because the markets have fallen.

For those of you that have not yet started planning or saving for retirement, start now. It is never too late! For those with 10 or more years to retirement – capital growth should still be your primary aim. For those with shorter period to retirement, capital growth and preservation should be your primary goals.

In the next article I will look at Retirement Annuities as a retirement savings vehicle.

Remember, if you have concerns about your finances or financial positions, you should be speaking to your financial planner.

*the stats are quite vague around this issue, I have seen figures as lows as 5-6%; suffice to say that by far the majority of South Africans will not retire financially independent.
**I remember hearing this at a conference but could not find the source
# typcially cash does not outperform inflation over time

It’s so easy to save money

It’s so easy to save money!

One of the “compulsory” forms of insurance that people with bonds have to have is Home Owners Insurance – this is insurance that covers the cost of replacing the building if it is destroyed through things like fire and floods. Usually the bank that provides the bond also very kindly arranges this insurance and the unsuspecting home owner signs the policy document. There are at least 2 huge problems with this:

Firstly , while this form of insurance is compulsory for those with a bond (and probably advisable even if you don’t have a bond) the insurance companies that the banks use tend to be very uncompetitive. If you ask the company that covers you for all your other short term insurance such as your car and house contents for a quote on your home owners insurance there is a very good chance that you could see a ±20% reduction in the cost of the cover. In this instance it makes no sense not to move and consolidate the cover with all your other short term insurance (just make sure you are getting like-for-like cover). I have recently had 2 experiences where the premiums have been reduced from ±R460 to ±R290 per month and from ±R226 to ±R175 per month – this is a substantial saving and in the second example, the bank was prepared to reduce their premium to match the quote from the outside insurers. All it took was 2 phone calls.

The second big problem with the bank arranging the cover is that the premium usually comes off your bond account each month – this is a huge rip-off because you are effectively paying interest on this premium over the life of the bond. Even if you don’t change the insurance provider get the bank to take the premium of your everyday banking account as opposed to your bond account – without even doing anything else you will knock years off your bond term. If you do change cover, it is likely the bank will want an endorsement on the new short term insurance contract noting their interest in the insurance – this is pretty standard practice.

If you have concerns about your finances or financial positions, you should be speaking to your financial planner.