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Durban - Millennials (those currently aged between 15 to 35 years old) have a lot going for them when it comes to investing, according to Ebrahim Moola, founder and investment professional at Sterling Wealth & Investments.
Besides having a very long investment horizon, these investors have access to information and investment asset classes that previous generations could only dream about.
"The SA millennial investor now has a fantastic opportunity to invest in the stock market without paying any taxes on his or her investment return via tax free savings accounts (TFSAs). Besides not paying taxes, TFSAs are extremely affordable with the minimum investment starting from as little as R500 per month," said Moola.
If millennial investors follow the key investment principles of starting to invest early in life, being consistent with their investment contributions, investing in growth assets like the stock market and diversifying their investment exposure, there’s no reason why they can’t become a stock market millionaire one day and achieve extraordinary financial prosperity, according to Moola.
Tax free savings accounts
Just over a year has passed since TFSAs were officially introduced to the SA public by Treasury.
"The take up has been rather impressive. Minister of Finance Pravin Gordhan announced during his 2016 budget speech that roughly 150 000 accounts were opened over the past year with around R1bn added to total savings," said Moola.
TFSAs were primarily introduced to encourage a culture of saving among South Africans. SA has amongst the worst saving rates in the world (15.4% of gross domestic product (GDP).
What is a tax free savings account?
It is a structure that allows an individual South African investor to invest upto R30 000 per annum (R500 000 over a lifetime) without paying any taxes on the investment return.
The usual taxes payable on investment returns are income tax on interest received, withholding taxes on dividends received and capital gains tax upon sale of the investment. None of these taxes apply to a TFSA. The longer you invest, the higher the investment return and, therefore, the higher the tax saving.
In Moola's view, the first R30 000 per year in savings money a South African investor has, should be contributed towards a TFSA.
"The significant tax savings potential coupled with an easy-to-understand structure makes it a very attractive investment option, especially for the millenial investor," said Moola.
A working example
Justin Swift diligently starts investing R2 500 per month into a diversified TFSA account at age 25. He continues to do so for a period 16 years and 8 months until he exhausts his lifetime TFSA allowance of R500 000.
We assume a personal income tax rate of 41% and an annual return on investment of 12% (6% capital growth, 3% interest income, 3% dividend income). After 25 years, his TFSA account is worth R3.85m. Assuming he invested the exact same amount and achieved the exact same return in a normal investment account, his investment will be worth only R3.1m. So merely being invested in a TFSA has added over 19% (or over R740 000) to his investment value after 25 years, a significant difference.
Millennial money
Moola refers to a book by Patrick O'Shaughnessy entitled Millennial Money – How Young Investors Can Build a Fortune and says the key investment principles of the book are rather simple and ties in perfectly with his own investment philosophy at Sterling Wealth & Investments:
- Start investing early in life (so you can enjoy the benefits of compounding returns);
- Be consistent with your investment contributions (and don’t try to outsmart and time the market ups and downs);
- Invest in growth assets (over the long term, the stock markets have produced inflation beating returns and is the best performing asset class available to the individual investor);
- Invest globally (diversify away from your country of residence).
In Moola's view, TFSAs enable the young South African investor to achieve all of the book Millennial Money’s key principles and with the added benefit of being the most tax efficient structure to boot.
What underlying investments can be made?
South African financial service providers have made great strides during the past year to open up various investment options within TFSAs to cater for the various investor affordability and risk profiles, according to Moola.
These include:
- Cash and fixed deposit investments;
- Various equity based ETF products;
- Unit trust investments (local and offshore).
Due to current regulations however, a TFSA cannot invest in unit trusts that charge performance-based fees.
"While this does limit the investment universe somewhat, there are still hundreds of potential investments to choose from. The Millennial Investor is able to build a diversified basket of equity unit trusts with local and offshore exposure with the assistance of a savvy investment adviser," concluded Moola.
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