It’s impossible not to notice the great divide between the MSCI Word Index return and our JSE’s return over the past 10 years:
JSE All Share: 9.6% per year
MSCI World in rands: 19% per year
No wonder South Africans are taking a one-way bet on the rand and the local economy, and some investors have started channeling 100% of their investments offshore. But, with the exception of one group of investors, investing 100% offshore is perhaps not the best strategy.
The exception: soon-to-be emigrants/ expats should in fact invest 100% offshore
If you’ve already made a firm decision to leave the country and settle overseas for good, even if it’s not a formal emigration and you’re considering more a fluid expat lifestyle, there’s no point in delaying it any further. All your long-term savings that’s not locked up in a retirement fund should be moved 100% offshore. (What to do with your retirement fund now deserves a post of its own.)
Offshore ‘proper’ vs. offshore ‘lite’
Bear in mind that there are two main types of offshore investing:
Offshore ‘proper’ where your investment account is domiciled in a country outside of South Africa, like Bermuda or the Isle of Man or Luxemburg (Reserve Bank approval is always needed but tax clearance is only necessary if you take out more than R1 million per year, with a limit of R11 million per year)
Offshore ‘lite’ where you use a local asset manager’s asset swap capacity to feed into an offshore exchange traded fund (ETF) or unit trust fund (you don’t have to worry about the Reserve Bank or tax clearance in this case)
With offshore ‘proper’ – unlike offshore ‘lite’ – you can receive your money in any bank account in the world when you withdraw it – no questions asked. Your money is truly out of the country and stays there.
Soon-to-be expats should go full out for offshore ‘proper’
If you plan to cut ties with South Africa, take your full financial freedom savings pot out of the country (offshore ‘proper’). Just keep an emergency and relocation fund in SA for your big rand expenses to last you from now until your date of departure. Once you’ve left SA, all your future expenses will be in another currency and there’s no point in anchoring your FIRE savings pot to the rand. (Should you by any chance change your mind or need some of your money for a big emergency before you relocate, you can always ask for it to be paid into your SA bank if your expense needs to be settled here. It takes between 7 and 14 days.)
For those lingering in SA, there are 7 reasons why investing 100% offshore is not great
For everyone other than imminent expats, investing 100% offshore is not a great idea, because:
It’s not true that offshore always outperforms local
With offshore investments you miss out on tax breaks
Offshore means extra investments fees and other costs
Your admin burden can be so much higher
Your heirs could end up paying higher estate duty or not inherit at all
Rand volatility may give you sleepless nights
Your savings pot is in dollars but your future expenses in rands
1. It’s not true that offshore investments always outperform local
Let’s look at the previous two decades’ data:
Index Jan 2001 to Dec 2010 Jan 2011 to Dec 2020
FTSE/JSE All Share 9.9% per year 9.6% per year
MSCI World (in rands) 0.9% per year 19.0% per year
We’ve already talked about the stellar past decade of the MSCI World. What we hear less about is how that same index , in rand value, gave an almost flat return to South African investors in the first decade of this century, compared to the nearly 10% per annum from the JSE over that same period. With a strong outlook at the start of 2021 for resource rich countries like SA, will the next decade perhaps be the JSE’s turn to outperform? It’s not impossible.
2. With offshore investments you miss out on tax breaks
If you’re just starting out on your journey to financial freedom, it’s best to first settle your debt, set up an emergency fund and get to the place where you can max out (currently R36 000 per year) your tax-free savings account (TFSA) year after year. Only after that you can start looking at putting part of your spare cash in a tax-deferred retirement annuity (RA) and a part in a non-TFSA offshore account. You could of course go offshore ‘lite’ with your TFSA too, by investing in an ETF like the Satrix MSCI World or the Asburton 1200. But it’s what you do with the additional spare cash after you’ve made your full annual TFSA allocation, that I’m talking about here. If you put all of that spare cash into your standard, taxable offshore account instead of an RA, you miss out on the tax-deductibility of RA contributions and the option to allocate up to 30% of your RA to offshore. You will also have to pay dividends tax and capital gains tax on your offshore account.
(By the way, even inside a TFSA you will not be able to enjoy the full dividends tax exemption if you choose a fund with offshore dividends, such as a global equity ETF. Your local ETF manager can only retrieve some of the dividends tax paid to other tax jurisdictions on your behalf. It’s only local dividends that are fully tax free inside a TFSA.)
Also, while the dividend withholding tax on local dividends is currently 20%, some other jurisdictions have a much higher rate. Notably, the US rate is 30% where no treaty exists between the US and the jurisdiction in which your offshore account is domiciled.
FIRE peeps older than 55, other than an RA, also has the option of a living annuity to invest in tax free and offshore at the same time.
3. You will have extra investment fees and other costs
How much extra your fees are when you go for an offshore account all depends on which account you chose. But there’s no getting away from the foreign exchange charge when you initially convert your rands to dollars or euros.
Also keep in mind that a global equity feeder fund often has an additional layer of fees. While you may see only the total expense ratio (TER) for the feeder fund on its fact sheet, the fund into which it’s feeding could also charge a management fee.
4. Your admin burden could be so much higher
If your offshore account is not overseen by an SA administrator, your admin burden could be so much higher. You won’t be receiving tax certificates with all your dividends, interest and capital gains broken down exactly the way SARS requests it – and with the correct source codes. You would have to do figure out the reporting yourself. Fortunately, there are a slew of local administrators of offshore accounts in SA now. Allan Gray has been doing this for years, and Easy Equities also came to the party in 2017.
5. Your heirs could end up paying higher estate duty or not inherit at all
Another consideration, although you won’t be around to pay it, is how much the estate duty on the offshore portion of your portfolio will be. In the UK, for example, estate duty is 40% compared to South Africa’s 20%. But more worryingly, there could be restrictions around who may inherit assets, for example only spouses and proven family members, or only male heirs in some countries. Always ask what these laws are in the country in which your investment will be domiciled before you take money offshore.
6. Rand volatility may give you sleepless nights
For long-term investors with an appetite for risk, this one shouldn’t matter that much. But if you’re a conservative or more cautious investor, even putting your entire portfolio in offshore cash could be too much to stomach. Being offshore introduces currency risk: the up-and-down movement of the rand value of your account even if your amount of dollars in the offshore bank account stays constant. That’s what currencies do, but the rand – as a liquid and readily tradable proxy for many emerging market currencies – is particularly volatile and unpredictable. Every time Turkey or India sneezes, we catch a cold.
7. Your savings pot is in dollars but your future expenses in rands
Asset-liability mismatch is probably the biggest reason why investing 100% offshore is a bad idea.
If there’s a big mismatch between the currency in which you’re investing and the currency in which you’ll need to settle your future bills, you’re running asset-liability risk. That’s the risk of your assets not giving you sufficient cashflow during some years to pay your bills, if the rand strengthens significantly in those years. In other words, it’s when the rand equivalent of the dollar or euro income you are drawing ends up being too low because of a strong rand.
If investing 100% offshore is a bad idea for most South Africans, what percentage then should you take offshore? More in my next post on how to use your future expenses – and a few other factors – to help you decide how much to allocate to offshore investments.
Article reposted with permission from Go Freedom.