Start saving: guaranteed investments
Markets will fluctuate – now and in the future
Conan O’Brien is an accomplished American television host, comedian, writer and producer. He has an IQ of 160, the same as that of the late Stephen Hawking, the famous physicist. Therefore, when O’Brien has this to say about the financial markets, although tongue in cheek, I tend to take note. He is touching a nerve or two with the following: "Today the stock market plunged 600 points and One Direction announced they're breaking up. Yes, both of these things happened. It was good timing for me because when people asked why I was sobbing uncontrollably, I was able to blame it on the stock market."
He was downplaying the ultimate investment test of one’s nervous system, investing in a time of serious market fluctuations. Who remembers 2008 as if it was still yesterday? The investment markets may at times feel like a proverbial roller-coaster ride, with the investor never being able to anticipate the dips and the inclines. This graph of the Dow Jones illustrates the effect of the 2008 market crash.
The following graph represent the last 100 years of the Dow Jones with the 2008 crash identified with an arrow. At the time, it felt like the world was ending, but for the longer term it is merely a blip on the charts.
Short and medium-term investment needs
Not trying to be an investment specialist but merely commenting as a novice armchair guru. It is not rocket science to figure out that assets with high volatility in the short-term (such as stocks) tend to produce higher investment returns over the long term, compared to assets with lower volatility such as money markets.
The purpose and needs of an investment may require something more than the ebbs and flows of the long-term investment “river” or being fully at the mercy of volatile market returns. This is where guaranteed investments fit in the investment universe.
Most investors with short-term investment goals want to know:
- What products will guarantee no loss of capital or annuity income?
- What products ensure reasonable growth, making reference to real return?
Note: the definition of real return is the return an investor receives after inflation has been taken into account.
Sometimes you do not have the luxury of a 100-year investment period as per the above Dow Jones chart.
A guaranteed investment is a structured product designed to protect your capital. Bonds could be the underlying asset class.
Guaranteed investment options
With market fluctuations in mind, you may rightfully ask if a specific investment can guarantee your income or guarantee growth on your capital. When you have discretionary capital available earmarked for short to medium term needs, you definitely do not want to expose it to market risks and fluctuations.
Think about that bonus set aside to buy something in a couple of months or the proceeds needed to fund children’s studies. Some of you may need guarantees on investment capital or income for shorter periods.
When investing, you sometimes have to choose between volatile markets versus guarantees on your capital or income. After you have conducted a risk profile for a specific time and purpose, then multiple guaranteed investment options are available. Please remember to ask yourself the following questions:
- When do you need the investment to mature?
- What is the purpose of the investment (children’s studies or a guaranteed income)
- Are you comfortable with the real return that is guaranteed, considering inflation?
- Do you understand all the costs involved?
- Do you maybe have capacity and tolerance to look for alternative investment with possible better returns but no capital guarantee (referring to investments with a 3-year plus term)?
- Is this guarantee rate too good to be true, meaning is there underlying risk that you don’t understand?
- Are you dealing with a reputable institution or financial service provider?
When do you need a guaranteed investment?
The typical structure of a guaranteed investment is a single-premium, linked endowment policy providing a guaranteed maturity return after five years or a single-premium, linked, term-certain annuity policy providing a guaranteed monthly income over the five-year investment period; or a combination of the two. This is the perfect product if you:
- Wish to have certainty with regard to maturity value and/or income received
- Require a tax efficient investment vehicle
- Require the investment to fit into your estate planning (referring to executors fees, capital gains tax, liquidity or estate duty)
- Have voluntary savings to invest
- Are able to invest for a fixed term (for example five years)
The features of a guaranteed investment:
The salient features and structure of a guaranteed investment five-year plan includes:
- Guaranteed tax-free returns in the hands of the investor at maturity
- A guarantee that the amount payable upon death of the last surviving life assured will not be less than the amount invested.
- Ability to cede the policy as collateral to a financial institution.
- Accessibility through a single full or partial surrender, subject to restrictions and costs.
- The option to appoint beneficiaries on the investment. This can lead to potential savings on executor’s fees in your estate. When you nominate a beneficiary the payment of the death benefit does not depend on the winding up of the estate and beneficiaries will receive the proceeds relatively quickly.
- Access to the money: After the maturity date, you have access to the investment funds through lump sum or regular withdrawals. These withdrawals will always be tax-free.
- The guaranteed investment is taxed as follows:
1. The investment is taxed “in-fund” in terms of the five-fund approach, and for individual investors and most trusts, that means the income in the fund will be taxed at a flat rate of 30% and an effective capital gains rate of just 12%.
2. This tax structure, by default offers an attractive tax-efficient benefit for the investors whose marginal tax rates are higher than 30%, or for trusts with a 45% income tax rate.
3. When you need to receive a guaranteed income with a guarantee on the initial capital, only a portion of your guaranteed income is subject to income tax, meaning potentially lower income tax.
What is inflation and the impact thereof on investments?
Before you rush to your trusted financial adviser to get the most recent guaranteed interest rates or the rate of return, spare a moment for the investor's worst enemy and the silent assassin of savings. Maybe even deserving the title "public enemy number one". All these unflattering titles belong to inflation. Therefore, before you just fix the growth on your capital for a certain percentage and time period, make sure that you understand the implications thereof. You may miss an opportunity to be in the market where the growth on your investment could be higher than the fixed rate of the guaranteed investment.
A 6% inflation rate will almost halve the value buying power of your money over 10 years. After 20 years, your investment will lose 70% of its purchasing power. This is why your investment needs to deliver returns that outperform inflation over time. Careful planning and consideration should be at the order of the day when you deal with your investment planning. You do not have minus 5% inflation one year and then plus 5% the next year. It is a persistent and continuous killer over time. Make sure that your investment choices fits in your bigger financial planning blue print.
Rather get expert advice to understand your risk tolerance and risk capacity. This will help you make an informed decision. An adviser will also have access to data that will help you identify the best possible guaranteed investment option.
Risk tolerance will vary between age, income band and financial goals. It also refers to how much volatility the investor can tolerate when viewing investment returns over a short period of time.
Risk capacity on the other hand refers to the willingness of the investor to take risk to achieve a set goal. It also refers to the total risk exposure and how it aligns with the strategy and objectives of the investor. It also refers to the question as to how much the investor can afford to lose on the capital invested.
Get your Personal Financial Plan created and managed by an Absa Financial Advisor. At the same time, obtain the necessary investment advice from an Absa Financial advisor when it comes to guarantees on your investments. Send an e-mail to AdviceGurus@absa.co.za or call 011 225 1797 and start your journey of financial planning success.
Disclaimer: The advice contained on this blog is for general purposes only and does not take into account individual circumstances, objectives or financial needs. Accordingly, readers are advised to seek appropriate advice from licensed professionals prior to making any investment, or taking up a financial product or service.