Knowing how the time horizon of different types of investments affects savings outcomes can help investors choose the most appropriate investment vehicle to earn the best possible growth over time.
The savings levels of working South Africans are low at just 15% of their income. But according to research on the South African market released this year, savings for the entire population is even lower at just 3%.
Investors often choose bank fixed deposit accounts and money market funds as both benefit from set interest rates and provide fairly easy access to savings. Average 12-month interest rates for fixed deposit accounts from South Africa’s four biggest banks are currently around 6% to 8%. Average money market rates are around 7.5% to 8.5%. With money market funds, investors can get access to their money within 24 hours, which is a significant benefit.
By choosing to “move up the yield curve”, which means investing in fixed income funds, investors can get average returns of between 8% and 9.5%, immediately adding almost 2% extra in returns while keeping within a low-risk investment. What’s more is that investors still have access to their funds within 48 hours, which is a major benefit.
Income funds (from low risk to more aggressive) sit on the conservative side of the efficient frontier risk spectrum. An efficient frontier simply shows the opportunity to earn higher returns for the more risk you take on.
Also within the low-risk investment category and with a time horizon that can extend from a few months to several decades are unit trust tax-free savings accounts. These provide access to underlying funds and are a good way to combine tax efficiency with investment savings.
Investors can save R33 000 a year up to a lifetime limit of R500 000. Growth on investments is tax free and so is the money that investors withdraw from the account. Used as a pre- and post-retirement savings option, tax-free savings accounts can have a lifespan of 40 years. Twenty years pre-retirement to accumulate assets and 20 years post-retirement when money can be withdrawn tax free to help supplement retirement income in a tax-efficient way.
Further up the time horizon spectrum is equity-based investments, such as property, equity and balanced funds. These require a time horizon of more than five years as the opportunity they provide to earn higher returns also comes with higher risk.
Over the long term, equities have proven to be the highest-performing asset class but short-term downturns can take years to recover. The risk of having an investment time horizon of less than five years is that investors’ portfolios may not have sufficient time to recover short-term losses, if they occur.
Equity returns vs bonds and property over 23 years
Balanced or multi-asset funds, have an investment time horizon similar to equity funds, typically around seven to 10 years as managers focus on longer-term macroeconomics and business cycles to position portfolios for growth, while keeping volatility low.
Balanced funds aim to provide investors with “the best of both worlds” by including exposure to equities and bonds. The equity allocation can be as high as 75%, dropping to 60%, which is still fairly high.
Understanding investment time horizons is not just about ensuring investors’ portfolios have time to recover if there is a market downturn, it is about understanding the mindset driving managers’ decisions.
Investing in a balanced or equity fund positioned for a business cycle five to seven years ahead, when your personal time horizon is less than five years, means your outlook is not aligned to how the manager is managing the fund.
Investors can go wrong by choosing an equity or balanced fund and then stressing about short-term underperformance when the manager is managing the portfolio for the long term.
Investment time horizon of different types of investments
At the far end of the time-horizon spectrum are private equity and other alternative investments such as infrastructure and credit funds, which are longer-term investments typically only available to high-net-worth investors with a minimum lump sum investment of R1 million.
Private equity involves buying a stake in a private company and transforming it by replacing management, introducing new product lines or selling non-core business units, a process that can take years.
However, eligible investors should not be put off by the time horizon. Most people will open an education fund when their children are born with a time horizon of around 20 years, which aligns with private equity, provided an investor’s other investments are sufficiently diversified.
Over the past 10 years ending December 2016, private equity funds managing assets of between R500 million and R1 billion returned 18.6% per annum according to the latest RisCura SAVCA South African Private Equity Performance Report. South African equities returned 15.6% over the same period.
Realistically estimating a savings time horizon is about effective planning. It is the first step to consider in investing planning and determines the types of investments available for investors to choose from.
It is important not to over- or under-estimate time horizon. If, as an investor, you are not planning to access your savings for 10 years, consider investments with a higher return profile that can enhance your returns for the time you are saving.
The longer you are prepared (and able) to leave your money untouched, the greater choice you have of different types of investments. In times of volatile markets, it becomes even more critical to realistically estimate your time horizon to get the most from your investments.
Anthony Katakuzinos is the chief operating officer of STANLIB Retail.
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