Johannesburg - In 2014 I travelled to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholders meeting. Thirty-nine thousand shareholders in Warren Buffett’s famous holding company travelled from around the world for a six-hour question and answer session with the 84-year-old Buffett and his 91-year-old business partner Charlie Munger.
Buffett has referred to the meeting as “Woodstock for Capitalists”. If you were attentive and took in every word, you would have heard all about the company in immense detail, with matters such as preferred annual returns, bolt-on acquisitions, return on investments etc.
Being slightly more of a layman, I preferred to listen out for the high-level wisdom that Buffett dispenses. He has a way of simplifying life and business down to common sense - Buffett famously only invests in businesses that he himself can understand.
I feel the same way. It is crucial to un-cloud complicated money matters and to look at things on a fundamental level. Most of us spend the majority of our lives working hard for our money, but how much time do we spend thinking philosophically and simply about the everyday ways in which we spend and hopefully invest it?
These are some of my basic money tips:
1. Pay your DStv account upfront for the year
This is my number one tip to anyone who asks me how to start saving money. It’s the best, guaranteed saving I’ve seen on a R9 000 upfront spend. If you’re saving money into any sort of risk-free investment, you should seriously consider holding back the first R9k and paying it over to our friends at MultiChoice at the beginning of each April. I’d look at this as if it were an investment.
Here’s why: as they do each year, DStv increased the cost of DStv premium (including access fee) from R740 per month to R780 per month from April 1. That’s an increase of R480 per year. However, if your account is paid upfront for the year before April 1, Multichoice will charge you last year’s price. What’s more, they will also only charge you for 11 months!
Let’s calculate the saving/return they’re offering you: (R480 + R740)/R9 360 = 13%. Obviously, if you kept the money in an interest-bearing account and let the balance diminish throughout the year you would earn interest, which is an opportunity cost to you.
But this is minimal compared to the 13% on offer. If you pay the R9k on your credit card, you could even roll the physical payment for another two months (at which point you would already have paid three months of subscriptions anyway), but we’ll get to that later.
2. Switching funds triggers CGT
This might not sound like something particularly important until it happens to you – and I’ve seen people hit by it twice this year already. When you move money between funds within an asset manager or a bank, capital gains tax is triggered. For example, you invested R500k in an equity fund 5 years ago. Your money is now worth R750k.
You decide that the market is a bit too volatile for your liking and you switch the money into a balanced or a stable fund. A capital gain of R250k is triggered and you will be required to pay tax of R33 825 [R250k x 41% (tax rate) x 33% (CGT inclusion rate)] if you are in the top tax bracket.
Of course, you will have to pay the CGT at some point in your life when you cash out the investment anyway. It just brings the cash flow forward. If you’re not expecting it, this can be a big hit for you. Make sure you double check the tax implications with the financial institution before doing something like this.
3. Tax-free savings accounts are a must
Tax-free savings accounts are a new savings product introduced in South Africa this year through government legislation. They allow you to save a maximum of R30 000 per year (and R500 000 in your lifetime) into a specially designated fund/account.
Often, these are the same funds that you may already be investing in (if so, you might as well change over by opening a tax-free version of that account). For anyone looking to save long term, these accounts are an absolute must-have because no tax or withholding tax is payable on your capital gain or on your dividends/interest earned.
In my opinion, it is ideal for younger investors to invest this R30 000 in high risk/high yielding funds as opposed to stable funds/fixed deposits. Firstly, the larger the gain you can potentially make, the higher your potential tax saving will be when you eventually cash out. This is different to a pension/retirement annuity where your main tax saving is on your upfront contribution.
Secondly, we all already receive an interest exemption annually, which should be exhausted on your more stable, interest bearing investments. The tax-free-savings account could then be used for dividend-yielding investments.
What is also important to note is that once you cash out your investment, your lifetime allowance into the savings account is depleted by the base value of the amount you cashed out. So it makes sense to let this money grow for as long as possible.
Lastly, if you have a family, I would consider investing the 30k per year for every family member on the first day of the year (giving your money as much time to compound as possible). Keep in mind that you are only allowed to donate a total of 100k per year to your children/spouse tax-free. So if you have more than three dependants, don’t forget about the donations tax implications.
4. Don’t keep idle money in your bank account
By far the most profitable type of deposit for a bank is what they term “idle deposits”. An idle deposit is money that an account holder leaves in their current account earning very little or no interest. The majority of that money is lent out as short-term loans and the bank makes a fortune on the difference between the interest charged and the interest it pays (or doesn’t pay). My bank account, for instance, earns the tidy sum of 0.2% interest on balances above R100k.
Many of us leave money lying around in current accounts earning nothing, while spending our time complaining about the 13c per litre increase in the petrol price. My suggestion would be to:
• Move the money in and out of your bond for short-term purposes (if you have a flexi-bond);
• Move the money into a money market account or seven-day call fixed deposit;
• Use your credit card effectively (to be discussed later in the article); and
• Apply for a Facility or a “One Account” (FNB).
The latter is a truly ingenious product offered by FNB. It turns your home loan into an overdraft on your current account. As an example, let’s say your home loan balance is R1m and your salary is R30k per month. Your salary is paid into your home loan, reducing the balance to R970k.
As you spend your salary throughout the month and your debit orders come off the account etc, the balance on the home loan increases again slowly back up to the R1m mark. In effect, you are saving say 8% to 10% interest on money that would have earned nothing until spent.
5. Saving into your bond
In November 2014, I wrote an article for Moneyweb about residential property investments. I received a lot of critical response for suggesting that saving into one’s bond/loan is a bad idea. Obviously, a lot depends on your personal financial circumstances. However, I still propose that paying off your home loan as quickly as possible does not always make financial sense. My reasons for this are twofold:
1. Interest rates have been extremely low for the last few years, to the point where it has been fairly easy to find an investment that will earn you a better return than the interest saving you can make by repaying capital on your loan. Perhaps this will not be as true going forward if interest rates increase sharply and the market pulls back somewhat.
Paying off other debt can also be a better investment than your bond. I recently met someone who was saving monthly into their bond even though they had a car loan and credit card debt – always remember to pay off your more expensive debt first. If you are more of a passive investor or you are very risk-averse, then saving into your bond is a better option than a money market account or a fixed deposit.
2. Interest paid on a loan for an investment property is fully tax deductible. If you are in the top tax bracket paying 41% on each rand of marginal income you earn, you will be entitled to a tax deduction of an effective 41% on each rand of interest paid. If your loan interest rate is 9.25% (prime), your effective cost of interest is actually only 5.45% (9.25*0.59).
Lastly, if you’re going to save into your bond, make sure that the bank does not capitalise that payment and that you have a flexi facility so that you can access it later on as a form of cheap finance for another property, a new car etc.
6. Understand how to use a credit card
A credit card can be your best friend if you know how to use it correctly. Of course, banks earn crazy amounts of interest from credit card users who don’t pay their balances on time each month. Here are some basic things many people don’t know about credit cards:
• The 55 days interest-free credit doesn’t necessarily start from the day you swipe your card. It starts the day after your statement date. Each day after that, you have 1 less day to pay back the money all the way down to 25 days. For example, if your statement date is the 13th of the month, you will have 55 interest free days if you swipe on the 14th and 54 days if you swipe on the 15th etc. If you swipe the day before your next statement date – on the 12th - you will only have 25 days to pay.
• If you do pay the “minimum repayment” (and not the full payment), you are charged interest. If you don’t pay the “minimum repayment” on the card, you are charged backdated interest from the day that you swiped the card (up to 55 days back)!
• The interest rate charged on your card is generally very high. Don’t fool yourself into thinking that this is a good way to borrow money.
If you manage your repayments properly (most banks allow for an automatic debit pull for the minimum amount due at 55 days), you can effectively roll your spend over for payment up to two months later. You should take advantage of this by investing the money that you would have spent in cash into short-erm investments to earn interest on the bank’s money.
7. Channel your spend to your credit card
I could write for a long time about credit card loyalty programmes – they’re somewhat of a passion of mine. I even tried to buy my car on my credit card. Programmes like eBucks (FNB), Greenbacks (Nedbank) etc can be lucrative ways to benefit from your existing monthly spend.
Depending on your rewards level, banks pay anything between 1% to 6% on everyday spend and I’ve seen up to 50% on fuel spend. There are certainly many hoops to jump through to get to the top loyalty earning bracket. However, at the least you should expect to earn 1% back on your credit card spend.
If you can channel an annual spend of for example R100k per year (R8.3k p/m) to your card, you could earn an extra R1 000 per year.
8. Medical savings account versus hospital plan
I’m going to write very generally here because I haven’t researched every medical aid scheme in South Africa. A medical savings account is a way for a medical aid to force you to save for day-to-day medical costs that the medical aid itself does not provide for in benefits.
In many cases, there is no difference in benefits between a hospital plan and a basic medical savings plan. The additional amount that you pay for the savings plan goes directly into your “savings account” until used.
For example, if a hospital plan costs R1 000 per month and a medical savings plan costs R1 500, the additional R500 x 12 months will be your savings for the year. This R6 000 is depleted as you use it throughout the year. If you don’t use it this year, it carries over to next year. If you leave the medical aid, they will pay the savings back to you. It’s your money. The medical aid just holds it for you – and pays you very little interest on the balance.
Obviously, if you happen to use up most of your savings in the first month or two of the year the medical aid is, in effect, giving you interest-free credit on the savings you’ve used but for which you have not yet paid (your break-even point here is 6 months).
But I suspect that this would not apply to the majority of members – otherwise the whole idea of medical aid would probably not work in the first place. If your savings are carried over for a second or third year, then there is a compounded lost opportunity cost to not investing the savings money yourself.
So if you have the self-control to save for day-to-day medical expenses and you are a fairly healthy person, a hospital plan could perhaps be better suited to you. NB: there are many schemes that do offer additional benefits on their savings option so you need to investigate this fully before making a decision.
Lastly, it’s important to note that if your company “contributes” a portion of your medical aid cost, it is often just a reallocation of your cost to company. Many people opt for more expensive medical schemes because they think their employer is paying more towards them.
In reality, the employer contribution is just an allocation and if you opted for the less expensive scheme, your take-home salary could be higher.
9. Tax benefits of pension funds and RAs
There’s a lot about pension funds that bugs me. They are one of the most fee intensive ways to invest your money. Most functions are generally outsourced to providers - from the admin to the investment decisions to the investments themselves.
In effect, this makes for a layered system in which everyone involved takes a cut in the form of a percentage of funds invested or a percentage of the return generated. Fees are charged all along the chain. On top of this, many pension funds are also mismanaged due to the disconnect between management and decisions made.
But you cannot avoid the massive benefits pension funds and retirement annuities (RAs) offer you from a tax perspective. Undoubtedly the biggest benefit is the full upfront tax deduction. This means that if you are paying tax at a 41% marginal rate, you will receive 41% of everything you contribute to your pension/RA in upfront cash from the South African Revenue Service (Sars)!
• If your pension is deducted monthly from your salary, the tax saving is embedded in your net salary received – the benefit to this is that your money has longer to compound in the fund, earning you tax-free gains. You also get an immediate tax benefit set off against your PAYE each month.
• If you contribute to the fund directly, you’ll receive the money back in the form of a refund when you submit your final tax return – the benefit here is that you can invest the money for the year yourself and make your contribution just before the end of the tax year.
I’ll let you decide which is preferable. But in effect, Sars is paying you to save money! Depending on how much your company is paying over for you already, you can also look at topping up your contribution to take advantage of the full deduction allowed (which is capped).
When you cash out (after the age of 55 aside for a few exceptions), you can only withdraw one-third of your funds as a lump sum and there is a partial tax exemption on this withdrawal. The remaining two-thirds must be paid as an annuity (fully taxed). So in reality, a portion of the upfront tax saving is recouped when you cash out, but there is still a major cash flow timing difference to take advantage of because you can invest the upfront tax saving elsewhere.
* This guest post is by Dean Gerber CA (SA), who works at VAT IT and is a residential property investor. He can be contacted on: firstname.lastname@example.org.
Disclaimer: All letters and comments published in MyFin24 have been independently written by members of the Fin24 community. The views are therefore their own and do not necessarily represent those of Fin24.
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