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Untangle the knotted web of investment terms

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Untangle the knotted web of investment terms

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As someone who gets excited about other people’s journeys to financial freedom, I love to ask what they’re invested in. But few people can speak confidently about their portfolios and investment choices. I often hear ‘I must be invested in Allan Gray funds because I get my statements from them’ from friends that were perhaps not told that you’re under no obligation to invest in a company’s funds if you’re using their platform. Another one I frequently hear is ‘I don’t like unit trusts, I’d rather just buy the index,’ from peers who haven’t caught on yet that nowadays a unit trust can be an active fund or index-tracking fund.

As we dig deeper to find out what exactly they’re invested in, it gets messy trying to untangle this web of terms that our industry uses. Is it possible to capture all the layers and layers investors’ money have to move through to finally end up in a basket of shares? I’m gonna give it a shot, but first we’ll need a picture to help us. I’ll provide the picture. You may want to pour your favourite shot of caffeine.

diagram of investment journey

Bypassing the industry is easy – if you have big bucks and don’t pay tax

There is a way to bypass the financial services industry completely, never needing to speak this language. Simply buy an asset, such as a house or apartment or a bar of gold directly. It’s the green route above. You’ll save yourself the headache of having to learn a whole new vocabulary of investment terms. But there are also plenty of cons to following the green route, of which I list only a few:

  • you can’t invest small amounts, such as R200 per month. You’ll need thousands.
  • You’re not building a diversified portfolio. Even if you buy 10 houses, you’re still 100% exposed to the South African property market and the local economy and interest rates. Great if we’re in a property boom cycle; not so great otherwise.
  • You’re potentially missing out on awesome tax breaks.
  • You might not be able to sell your asset quickly (liquidity problems).

Related: Buying property vs. buying shares

But tax wrappers could – legally – fast forward your financial freedom plan

So, the first thing you need to look at if you’re ready to boldly step into the world of investments, is a tax-efficient way of investing. There are several ‘wrappers’ – legal structures that change the nature of your investment so that you’ll be subject to different tax and other laws if your investment is wrapped within them. A general rule is that everybody should have an investment wrapped in a tax-free savings account (TFSA) and try and get as close as possible to the R36 000 annual limit – or R3 000 per month – that government’s put on this relatively new option. You will pay no tax on a TFSA at any stage of the game (except for a massive penalty from SARS if you invest more than the R36 000 annual limit). If you’re investing for the long term, make your TFSA contributions your investment priority, assuming you already have a separate emergency fund.

Then, if you have more than R36 000 per year to invest and you’re currently in one of the top 3 SARS income tax brackets, you might want to look at reducing your annual tax bill further by also investing in another common tax wrapper – a retirement annuity (RA). Just remember that with an RA you can’t touch your money until age 55 and will only be able to withdraw one-third of the value on retirement date (the one-third will be partly taxable). An RA is about deferred tax, and makes sense if you plan to be in a lower tax bracket in retirement. Remember to tell SARS about your RA contributions when you e-file, or you could miss out on a tax refund.

And make 100% sure you choose an RA with no hidden commission, complicated bonus systems or penalties. You should be able to add money as and when you want. And stop contributing at any time – penalty free.

For a TFSA you don’t need to work through a platform. But if you need a retirement wrapper, or if you want to invest in funds from different investment companies, you would need to work through an investment platform.

An investment platform is the face of your investment

Popular investment platforms include Allan Gray, Easy Equities, Glacier, Investec and Stanlib. They are the guys with whom you’ll interact along your investment journey – via call centres, instant messaging, apps, web login and email. So choose wisely. They’ll do a valuation of your investments daily so you can keep track of how they’re growing, and they send you regular statements and your annual tax certificates. Some have more tax wrappers than others, e.g Allan Gray has a preservation fund, an RA, a TFSA and an endowment policy, while Easy Equities currently has only a TFSA and an RA. They all offer collective investment schemes from many different investment companies.

If you don’t need a tax wrapper you can bypass the platform

If you need a tax wrapper, you’ll be following the blue route of my sketch above, starting at the investment platform. If you don’t need it, you can follow any of the red routes. You can either use the platform or go straight to a company offering collective investment schemes with the underlying funds that you’re interested in. For example, if you want to invest in the Coronation Balanced Fund, the Investec Balanced Fund and the Satrix Balanced Fund, you could either use a platform like Allan Gray or Glacier that offer all these funds, and only interact with Allan Gray or Glacier to get your investment values for and transact on all these funds. Or skip a platform and go to Coronation, Investec and Satrix separately to invest in their respective funds and get statements from each company separately. It’s more admin intensive, but will save you the small annual platform fee.

Who even uses the term ‘collective investment scheme’?

Not exactly gliding off the tongue, ‘collective investment scheme’ is the umbrella term for all sorts of funds in which retail investors can pool small – or large – investment amounts together with other investors wanting to invest in the same thing. Collective investment schemes include:

  • exchange traded funds (ETFs)
  • unit trusts
  • real estate investment trusts (REITs)
  • retail hedge funds

They’re an almost invisible legal structure that’s needed to invest in funds like the Satrix ALSI40 ETF or the Allan Gray Balanced Fund. So, even if you’re following the blue route, if you’re using a tax wrapper of any of the more modern platforms mentioned here, you will end up in a collective investment scheme. The blue route and the red route merge into a collective investment scheme. ETFs and unit trusts are the most common, which is why I show only these two in the diagram.

ETF or unit trust?

This deserves a post on its own. For now, let’s just say that whether you want an actively or passively managed fund would be the main driver of this decision.

If you choose an active manager, you’ll need a unit trust. If you choose passive, you have the choice between an ETF and a unit trust.

A unit trust can be either passively or actively managed.

An ETF is almost always passive – it tracks an index (also called rules-based investing). It’s generally cheaper than a unit trust, but not always.

Also check whether your current platform actually offers both ETFs and unit trusts. Glacier does for their retirement wrapper, but not for their TFSA. Allan Gray offers only unit trusts currently, and Easy Equities offers only ETFs. Depending on your choice between active and passive, and between ETF and unit trust, you may want to look at signing up with two platforms…

This is an excerpt from Go Freedom. See the full article here. Reposted with permission.

Related: Shares vs ETFs

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I’m Lizelle and I have no intention to retire from a working life. Only from my corporate life. I’ve been down many paths over the past 25 years: actuarial technician; investment performance analyst; product manager; hedge fund manager; client experience designer; finance forum owner; communication specialist; coffee stall owner; and Nia teacher (much fun). And I've been on a few sabbaticals, being a strong believer in proper breaks. I’ve been a salaried worker and a freelancer, and definitely prefer the latter. So, my next goal is to up-skill, cross-skill, invest in how I see my future self and save up some reserves, so I can return to the freedom of flexible work – for good. To me, financial freedom is a process; it's not an absolute destination.

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