The last 3 years has seen a lot of uncertainty in the market. You would not be blamed for having lost faith in your investment plan and harbouring serious thoughts of moving your funds away from growth assets into a “safe” investment vehicle.
The old adage that growth doesn’t occur in a straight line offers little comfort while your investment returns are dwindling and has seen no improvement for some time.
It is therefore only natural for your ears to prick when there is a promising offer on the radio or in the newspaper of an investment with a 10% guaranteed return without the pain of any market fluctuations. Like many things in life, the first impression isn’t necessarily the right one and a further analysis is required to make a judgement. There are several factors at play which could lead to different conclusions such as your marginal tax rate, current mandate and your long-term growth needs.
The impact of taxation
Do you fully understand the difference between tax on capital growth versus tax on interest income? Let me illustrate the effect of tax on a 10% fixed deposit investment of R3 million versus the same investment in a balanced mandate with an average return of 10.8% per annum.
The following assumptions were made:
After the tax man is finished with you, the return on your fixed-deposit investment decreases from 10% to 6.41%. What seemed like a good investment in the beginning, now barely beats inflation. In the balanced mandate you certainly don’t side-step the tax man, but the impact is a lot smaller.
There is a big difference between tax on interest income and tax on capital gains. Interest income will be added annually to your income tax return, whether you have received the income or not. Individuals younger than 65 years are allowed an annual exemption of R23 800 and if you are over the age of 65 you receive an exemption of R34 500. Due to the large inclusion of interest to the taxable income it moves this investor to the 39% tax rate. Keep in mind that this individual loses the growth on the taxable part, because SARS compels you to pay it annually whether he receives it or not. On the other hand, capital gains tax (CGT) is only payable upon the sale of the investment.
The effective CGT rate is a lot less than tax on interest. An individual receives an annual rebate of R40 000, and only 40% of the remaining capital gains are added to your income for the year.
Therefore, an individual will possibly pay up to 45% (the highest tax rate) on his interest income, but currently no more than 18% (40% of capital gains x 45% – the highest tax rate) on capital growth. Given the above, if you combine growth assets and interest-bearing assets, not only is the volatility of your investments substantially lowered, but tax implications are reduced too.
The price you have to pay to completely eliminate volatility, and as such only invest in cash instruments, is therefore very high.
Keep in mind
There are a few other aspects to keep in mind, since the above example addresses only one scenario:
If you are uncertain about the tax implications of your investments, ask an accountant or certified financial planner to explain the differences. It will most certainly impact your investment decisions.
Elmie de Jager is a certified financial planner and wealth manager for ProVérte Wealth & Risk Management. Contact her at firstname.lastname@example.org.
Although all possible care was taken in the drafting of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone planning on taking any financial action based on this document, is strongly advised to first consult with their personal financial advisor. ProVérte Wealth & Risk Management is an authorised financial service provider with FSP no. 5966.