Surprisingly, few people make use of a financial advisor. Many of us don’t think twice about hiring the services of an interior decorator or a personal trainer, but pass up on financial advice, which is one of the things we can least afford to get wrong.
Interestingly, the tendency is that the more people earn, the more they believe they can manage their own finances, but surveys show that there is very little correlation between earning well and being able to manage your own investments for success.
In theory, it may be possible to do your own financial planning, but you will need a fair amount of time to do research and the skills to perform financial calculations and projections in order to have a meaningful impact on your financial planning. In addition to this, you would also need to sift through the many options of medical and life cover, select the most appropriate investment and pension plans for your retirement, while minimising your tax and checking what will happen to your estate after your death. Given the extent of the work involved and that the potential consequences of making a mistake could be enormous, one would think that it would make sense to check with someone who is qualified in case there’s anything you’ve missed.
Death, critical illness and disability are subjects most of us would rather avoid discussing, but for those of us with dependents, there are huge risks for failing to do proper financial planning. Life insurance cannot hope to deal with the emotional aspects but it can minimise the financial impact should the worst happen. Where affordability is a concern, it might be worth reassessing and reallocating your finances to put in place the life cover and protection your family needs. Your financial advisor can assist with budgeting and is qualified to calculate the amount of cover required, which leads to the next point – over and under insuring.
There is a frequent misconception that when life cover is in place, it’s there for life. However, there is no such thing as a ‘one size fits all’ when it comes to life cover. We regularly find that clients either have too little life cover to maintain their lifestyle or they are over insured and applying funds to premiums that could be better invested elsewhere..
It warrants reviewing life policies with your financial advisor on a regular basis and especially at times of life changing events, such as getting married, the birth of a child or buying a property. At the other end of the spectrum, life cover might ideally be reduced as dependents leave home, houses are downscaled and retirement approaches.
Dalbar, a large research house in the USA, specialising in the analysis of investor behaviour, recently published a survey which analysed the investment returns for the average mutual fund investor (unit trust investments). They looked at the balanced mandate of 60 % equities and 40% cash and bonds and found the following:
The average investor had a 2.6% net annualised rate of return for the last 10 years. The same average investor hasn’t fared any better over longer time frames. The 20-year annualised return comes in at 2.5%, while the 30-year annualized rate is just 1.9%.
We are talking about a very large, sophisticated $ 4.5 trillion market.
To put this in perspective, the US stock market (S&P 500) had an annual compound return over these 30 years of approximately 10% per annum, yet the average investor had an annual compound return of only 2%. Why is this?
The main reason has become known as the Behaviour Gap. Human nature drives us to follow the herd. That is how we have evolved. However, this instinct compels people to switch funds at the worst times. We buy when the markets or particular unit trusts are doing well. So, we buy when they are expensive. Then we sell when markets or funds are doing badly. We sell when they are cheap. This is the opposite of what we should be doing! Your financial advisor can assist you with identifying these market trends and behavioural biases.
A professional advisor can help you maximise your use of retirement savings vehicles so that you save tax. Appropriate tax planning can add up to an extra 2% returns a year on your retirement savings, which is substantial over a 30-year career.
Retirement Annuities (RA’s), Tax Free Savings Accounts (TFSA’s) and Endowments are the three main investment vehicles routinely considered for tax efficient investing for retirement. Either one or two products or a combination of all three may be recommended depending on the age, stage of life and financial circumstances of the individual. This is best assessed by a qualified financial advisor.
With TFSA’s there is no tax on income or interest, no dividend tax and no capital gains tax. A wide selection of bank account products or equity funds is available depending on your risk profile and needs. You can also invest for minor children. An investment of a maximum of R33 000 per person per annum is allowed subject to a R500 000 lifetime limit.
Contributions to RA’s of 27,5% of gross remuneration or taxable income (the higher) are tax deductible subject to an annual limit of R350 000. For employees who also have a pension or provident fund, the total retirement funding may not exceed the said 27,5% or R350 000 for tax deduction purposes. By making RA contributions from pre-tax income, individuals are able to achieve up to 1/3 in upfront tax savings during their working years. Income tax and capital gains tax are not applicable to the investment return in the RA structure. Although RA’s do not pay out tax free at retirement, the effect of deferring tax to a point later in the future is beneficial to investors, as it allows investments to compound off a larger base up until that point.
Albert Einstein declared that ‘compound interest is the eighth wonder of the world’. This still holds true today. The most powerful force in investing is compounding. If you are able to compound off a larger base through paying tax later (in the case of RA’s), or you are able to compound for a longer period of time by investing as early as possible (for example TFSA and RA’s), this has a formidable impact on the returns generated over time.
When it comes to financial advice, the real issue is that knowing what financial products and choices are available, requires professional assistance. Being able to visualise the full long-term implications of multiple financial decisions and how they interact can make the difference between a mediocre existence and the lifestyle you want to lead.