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Long-term investment strategy

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What is the best long-term savings strategy for a South African paying tax at a marginal rate of 40%? Some people don't realise this, so I'm pointing out from the start that there is no investment strategy which is 100% guaranteed of generating the returns needed for you to have a comfortable retirement. In fact, there's far more luck involved than most people think - if you're fortunate to experience a bull market from the age of 40 to 70 you're far more likely to retire comfortably than the Gods decide that it's during those crucial years of your life that the markets should be in the doldrums.

This article looks at some of the principles - note that for a specific individual, their circumstances would need to be taken into account, so don't automatically assume this applies to you, you'll need to think through your own specific potential cashflow requirements, tax situation & psychological makeup to figure out what's good for you.

How much effort are you willing to put in?

The first thing to do is to decide how much effort you're willing to put in. Your investment approach should reflect the level of intelligent effort you're willing to put in. For example, if you're investing directly in stocks without carrying out proper analysis you're more a gambler than an investor. Let's compare the effort required to the amount of effort required to learn to play golf.

Investment expertise

Golf expertise

The minimum you can get away with is to do enough work to identify an investment professional you have complete faith in, and then delegate responsibility over to them. You need to have enough faith to literally hand over your life-savings to them. For example, if you have complete belief in Allan Gray, you could invest both your retirement fund money and excess investments in Allan Gray's Balanced Fund. This carries with it the risk that you've had faith in the wrong party. Even though this is the minimum effort required, there is a considerable amount of work involved in identifying the level of faith you have in an investment professional (whether it's an investment adviser or an asset manager).

This is akin to the average person putting enough effort in to get their golf handicap down to 15.

There is a large amount of additional effort required if you want to do more than this (properly). For example, consider that you want to take the seemingly small step of investing in equity-based exchange traded funds. You are now effectively making asset allocation decisions yourself, as you've decided to go overweight the rest of your holdings by the amount of the investment in the particular exchange traded fund, so you need to be have the expertise to decide what is an appropriate asset allocation, and/or have a valuation methodology upon which to base your decision of when to invest/disinvest. You would need to be able to analyse the best way to invest in the particular exchange traded fund and possibly need a bit of trading expertise to ensure efficient purchase of it. Last, but not least, you would need to be psychologically prepared, so as not to panic & sell at the wrong time.

The amount of additional effort is akin to the amount of work required to get your golf handicap from 15 down to 1.

If you're going to conduct direct stock purchases, then a serious level of effort, financial expertise & psychological strength is required (if you are this knowledgeable & willing, you're probably not reading this website!) to do it properly. You'll be competing with people who have 20 years or more experience at the game, who are full time professionals, and are paid large amounts of money to eke out alpha - and a large portion of the professionals get it wrong.

This is akin to the additional effort required to go pro.

Optimum Strategy

An optimum strategy generally involves the following:

(1) Pay off debt

If you still have any debt or mortgage payments, then it is usually sensible to first use free cash to pay off your debt.

(2) Set up a tax-efficient emergency fund

It makes sense to set up an emergency fund in case of, well, an emergency. Money market instruments & to a lesser extent bonds have a lower probability of capital losses than equities, so usually people invest their emergency fund in these instruments, especially if they have remaining capacity to earn interest on a tax-free basis (this legislation is in flux).

(3) Contribute as much as possible to your retirement fund

With dividends, capital gains and interest not attracting tax in a retirement fund it usually makes sense to contribute as much as possible to a retirement fund. Here, it is important to:

If you are in a company retirement fund which allows you to vary your contribution rate, you'll have to carry out an assessment of whether it's better to put contributions/additional contributions into the company retirement fund or an outside platform.

(4) Excess Assets

The easiest thing to do with the excess assets is to invest them with the same manager in the same way as you chose to invest your retirement fund assets. However, depending on your level of expertise and the effort you're willing to put in, there are a number of options (and it also becomes important to take tax into account):

You can either invest directly in preference shares via an online trading account, or via a collective investment scheme like the Grindrod Diversified Preference Share Fund, the PSG Preferred Dividend Fund or the Coronation Preference Share Fund or even the Sanlam Alternative Income Fund. If you do invest directly, be careful of some stocks which have been legally structured as preference shares, but have none of the usual characteristics of preference shares (e.g. RECM & Calibire Preference shares).

Check the secured investment rates with the various insurers (Clientèle Life, Hollard Life, Nedgroup Life, ABSA, Discovery, Momentum, Liberty Life & Old Mutual's Investment Frontiers). For a 40% marginal taxpayer there is something of a tax arbitrage going on here, and depending inter alia on the rates they offer, you might want to invest some of your money.

It takes some expertise to minimise the chances of getting your fingers burnt.

The alternatives are endless.

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