A Fin24 user writes:I have a dilemma. I have invested heavily in the stock market over the last two-and-a-half years and have done pretty well.
I have about R400 000 in stocks (of which about a third is growth on capital).
With my income, the bank is likely to only give me a bond of about R1.1m.
By cashing in the stocks and using them as a down payment, I can look to afford a R1.5m property. We live pretty frugally and could probably even afford the instalments on a R1.5m bond, but with the new credit act that is of course a moot point.
The stock portfolio is to a large degree my retirement fund, but with house prices and interest rates so low, I do feel now is a good time to buy.
Since I am only 30 and my income can be expected to grow substantially over the next few years through re-positioning within my job, I feel I should be able to make up for the retirement fund loss in a relatively short period of time.
Should I cash in my shares and buy a house, or should I maybe wait a couple of years for my income to allow me to buy a R1.5m property without the necessity of cashing in the stocks?
Nick Dekker, a financial planner with Ultima Financial Planners in Pretoria, responds:Both property and shares offer long-term capital growth, beating inflation over the long term.
Which one will perform best over the next 25 to 30 years? Who knows for certain? I am not going to speculate on which one will or might outperform the other; I will, however, mention a few points to put some expectations in context.
Even though residential property might seem slightly more affordable compared to two or three years ago, average growth over the long term has to be taken into account.
During the 1980s when interest rates peaked at above 20% and with political instability in SA, residential property values were not really going anywhere. Similarly, property prices were stuck in the 1990s due to uncertainty about the elections and new government.
But in the 2000s, thanks to lower interest rates and greater confidence in the country, residential property made up for the stagnant previous two decades. The last decade is what people tend to remember.
Compare it with the share market.
The main purpose of business is to produce profits. This is done by increasing profitability of companies and sharing the profit between shareholders. When profits are down, management will tend to focus on how to restructure a business to increase profitability to the required levels.
This profit-driven process has proven over time to produce superior returns compared to other types of investments like property, bonds and cash. People tend to overemphasise the short-term volatility risk of share pricing, which is no true measure of the share value.
It is unclear in your question whether you have you invested directly in the shares – or is the investment through a retirement product?
If it is a direct investment in the market and your share portfolio is merely considered as retirement provision, let's first look at the tax implication of selling your shares to buy a house.
Selling your shares will attract immediate capital gains tax (CGT). The actual tax on the said amount of R400 000 would be minimal as the first R20 000 of the actual gains will be excluded, and thereafter only 25% of the actual gain will be included in your annual returns for tax purposes.
Transfer duty on a property worth R1.1m will be around R17 000, compared to R37 000 on a property worth R1.5m.
If you hold on to your share portfolio, you will still earn your dividends annually and pay CGT upon sale of the shares. Currently individuals are not taxed on dividends, but this will change on April 1 2012 as the new Dividend Tax will replace Secondary Tax on Companies (STC).
This change, however, is a technical one where the company will pay the tax of 10% in the name of the shareholder, whereas currently tax of 10% is paid by the company in its own name.
If the share portfolio you refer to is actually invested in an approved retirement product (retirement annuity, pension or provident fund), there are of course other considerations.
These funds are usually not easily accessible before retirement age (in the case of pension and provident funds) or age 55 (for retirement annuity funds). I therefore assume that your mentioned retirement fund is in a preservation fund where you have an option to make a once-off withdrawal prior to retirement. Cashing in your retirement fund before you retire will immediately attract tax.
Upon withdrawal before retirement, only the first R22 500 will be taxed at 0% and the rest at 18% (up to R600 000). This will leave you (on an amount of R400 000) with only about R332 000 after tax.
Being invested in shares through a retirement platform means the investment structure is governed by legislation, giving certain guidelines and constraints. One of these is that your funds may not be invested in a single share or stock at any one time. It has to be somewhat diversified.
In effect, you will have to compare the prospects of tax-free growth on a diversified share portfolio of R400 000, or a lifestyle asset where you only have the benefit of about R332 000, "earning interest" (the interest you gain by not borrowing this amount) in a low interest rate environment.
And further, your retirement savings have been wiped out. Pushing your taxed retirement funding into a single lifestyle asset doesn't seem to make sense as the more expensive property would mean that you will not (at least for now) have the budgetary means of again "catching up" on your lost retirement benefit.
With the information at hand, at least for now, I wouldn't cash in shares for a lavish lifestyle just yet. Rather, wait until you can afford the bigger, more expensive house. After all, you mentioned the prospects of future income growth. Rather consider saving the excess income (left at the end of the month) until you have enough to put down as deposit on a more expensive house.
It would be advisable to get in contact with a qualified fee-based financial planner and have your goals and means documented in a financial plan.
- Fin24