free investment advice logo

Here's the deal: You may read the information on the site for free and ask questions. As and when I have the time I'll answer the questions on the website and add new articles. Please do not consider it to be advice - the only free investment advice is to apply your own mind. If you are worried about your investments, I am willing to have a look and improve it. If you are destitute I will try to help free of charge (but you join at the back of the queue). If you are not destitute then email me and we can agree a lower fee (percentage terms, repeating monthly, is fine) than you are currently charged. I have limited time available, and will prioritise the work accordingly, so please be patient. Email me at invest@freeinvestmentadvice.org detailing the situation for which you'd like advice. Rob Baker

I'm max'ing my RA investments & I don't like it

leave a comment

1 March 2012. Call me arrogant, but I think I can achieve better results than most asset managers, IF the taxation playing field was even. However, given the removal of dividend tax from retirement funds and the increase to 15% of the dividend tax on individuals in Budget 2012, I started wondering whether I am in fact better off handing my money over to the asset management industry. This analysis is based on a load of assumptions, some of which will undoubtedly be wrong, but I'd rather be partially correct than invest without thinking about the facts. I'm not a tax expert, so will happily accept any corrections from readers.

I need to outperform asset managers by roughly 1.5% p.a.

Doing it on my own has a guestimated tax drag of some 2.2% p.a. and an income tax differential of some 0.3% p.a., but a saving of asset management fees of 1% p.a. This means that I need to be able to outperform asset managers by 1.5% p.a. to make it worth my while to go it alone, rather than using a retirement fund. The working of how I got to these numbers follows later.

Government "forcing" me to enrich asset managers

I believe in my abilities, but I'm not sure that I could easily outperform asset managers by 1.5% p.a., and that is why I'm investing as much as I can in my retirement fund with Allan Gray. It's a pity that the government has chosen to make the taxation playing field so uneven, that one is forced to enrich the asset management industry rather than allowing citizens to take matters into their own hands.

How government can restore personal liberty

I can understand government wanting to encourage people to save for retirement, but it surely is not there intention to enrich asset managers at the expense of the personal freedom of its citizens.

There is a way of allowing people the liberty of carrying out investment activity themselves at the same time as saving for retirement. A reader pointed out that in the Land of the Free there's allowance for Self-Directed RAs.

Asset managers hate Self-Directed RAs, as they can't make FAT asset management fees, and would lobby against them. You would hear arguments that reckless investors would squander their retirement savings - but to me that's just part of freedom, that you've also got the freedom to stuff things up. Besides, it's not like all the professionals are showering themselves in glory - witness the rapidly shrinking portfolio that Sactwu invested with Trilinear, the Joint Municipal Fund's losses after dabbling in maize futures or money invested with Fidentia.

Portfolio costs

Assuming an average allocation of 50% to SA Equities, 25% to SA Interest-bearing assets and 25% to foreign equities we're looking at an average tax drag of 2.2% p.a.

 

Asset allocation

Guesstimated Tax drag

SA Equities

50%

1.9% p.a.

SA Interest-bearing

25%

3.2% p.a.

Foreign equities

25%

1.7% p.a.

Dividend tax (South Africa)

Investing by yourself generally attracts a dividend tax of 15% whereas retirement funds pay no dividend taxes. Assuming a dividend yield of 2.8%, this equates to an annual loss of 0.42% on South African equities.

Dividend tax (foreign)

This is the area I'm most uncertain of, but I assume that foreign dividends will also generally be taxed at the rate of 15%. At a dividend yield of 2%, this equates to 0.3% p.a.

Capital gains tax

The Capital gains tax rate was increased to 33.3% for individuals, and the annual exclusion to R30,000. Let's assume that stocks are held for 3 years on average, and that there's a gain of 36% over that period, and that there's no exclusion. There's an inclusion rate of 33.3%, so the included return for CGT purposes is 0.333*48% = 12%. Since my marginal tax rate is 40%, I'm looking at an average annual CGT rate of some 0.12*0.40/3 = 1.6%

To allow for the exclusion of R30,000 we need to assume an investment amount. Let's assume R1m, then the assumed gain over 3 years is R360,000, less a R30,000 exclusion gives R330,000. Since 33.3% of this is taxable, we have a taxable amount of R110,000. Applying a 40% marginal tax rate to a R110,000 gain gives R44,000 or R14,667 p.a. (on R1m, this equates to 1.5%).

Tax on interest

The Minister of Finance indicated that the tax-free interest allowance may be phased out in favour of tax-free vehicles, so for long-term planning it's prudent to assume that it's completely removed. For me this would mean interest being taxed at a rate of 40% (my marginal tax rate). If I'm earning 8% p.a. this means a tax drag of 3.2% p.a.

Tax exemption on contributions vs tax paid later

Investing in a retirement fund contains something of a hope that income tax rates at the time of retirement will be lower than income tax rates at present. I know that I'm saving tax now, at a rate of 40%, by contributing to a retirement fund. It's difficult to tell what rate of tax I'll be paying when I receive the money back in the form of an annuity & lump sum years later. As a complete thumbsuck let's assume a 6% saving, over 20 years that equates to 0.3% p.a. (this will obviously differ vastly between people, if your only source of income at retirement is your retirement annuity there may be a significantly larger saving).

Fees paid to asset managers

By investing by myself I don't have to pay asset managers anything. Let's assume that there's 1% p.a. I'm saving here (for simplicity of argument, ignoring platform fees as well as costs of an online trading account).

Trading costs

Trading costs are lower for asset managers, but they have to move larger amounts and therefore will move the market more. For simplicity's sake, let's assume that these cancel each other out.

blog comments powered by Disqus

Due to regulations, our emails and this entire website should be considered as having been set up for entertainment purposes alone. Expect errors and omissions. Investment in shares and other financial instruments should be conducted by professional investment experts only. Any use of the information on my websites, emails and newsletters is at your own risk, and by using it you agree that the owners of our websites, authors and associated parties wont be held liable for any losses suffered as a result of using the information. None of the information should be construed as being advice. Our newsletters, articles, discussions and website are not an offering for any investment. It represents only our and others' opinions. Any views expressed are provided for information purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest. Illustrations, forecasts or hypothetical data are not guaranteed and are provided for illustrative purposes only. There are risks involved in buying or selling a financial product. Past performance is not indicative of future performance. Any investment values given are not guaranteed. Investment returns can be volatile. When investing there is always the risk of losing all or a substantial amount of your investment, as well as the risk of illiquidity. There may be advertisements on some pages on this website, and we may earn income from these advertisements. We may earn commission on products invested in or annuities purchased. We cannot attest to the accuracy of the material presented here, and opinions expressed may be changed without prior notice. In any event our liability will be limited to R1, and any court cases must take place in Cape Town. Free Investment Advice is the trading name of South Africa Travel Online CC, a licensed Financial Service Provider (FSP number 43555). You may contact us at invest@freeinvestmentadvice.org