The Different Ways to Invest: What Does It All Mean?

South Africa has a very sophisticated savings and investment industry. The country’s financial markets, regulation and product range are world class.

However, ordinary investors don’t always appreciate what their options are. A study by Old Mutual in 2018 found that 47% of South Africans under 35 don’t know what a unit trust is. This isn’t because they’re ignorant. This group is well educated and tech savvy. But often financial jargon is not obvious to outsiders.

There is a lot of choice, and it’s clear from the outside what each kind of product is good for.

Here is a breakdown of the most common types of investment products, and how they work:

• Unit trusts

  Unit trusts are a simple way to get access to financial markets. Essentially, they pool the money from a whole number of investors, and buy shares, bonds and other assets on their behalf.

  This is much easier, safer and cheaper for most people than trying to buy those things themselves. There are also different kinds of unit trusts that have different levels of risk, and therefore different likely return profiles.

  Each of the investors in the unit trust has a share of ownership – their number of units. These can be bought and sold very easily. If you bought a company share, for example, you may need to wait to find somebody else to sell it to when you no longer wanted it. But unit trusts are open-ended, which means you can always buy and sell more units whenever you want to.

• Tax-free savings

  As a basic savings vehicle, unit trusts are used in other kinds of products as well. One of those is tax-free savings accounts.

  These allow you to make different kinds of investments – including in unit trusts, bank deposits and exchange-traded funds – and to hold them without ever paying any tax on the profits that you make. That means no tax on interest, no tax on dividends, and no capital gains tax when you take your money out.

  There are limits to how much you can invest in these accounts, but the longer you keep your money invested, the greater the benefit will be.

• Retirement annuity

  Retirement annuities are another product that can use unit trusts. And like tax-free savings accounts they have meaningful tax benefits.

  The first is that any money you contribute to a retirement annuity will be deducted from your taxable income. The second is that you will not pay any tax on any profits that you make while you stay invested.

  When you reach retirement age, you can also withdraw up to R500 000 tax free. You will, however, pay tax on the remainder.

  A third of your retirement annuity may be withdrawn as a lump sum. The rest has to be invested in an annuity product that pays you an income.

• Living annuity

  One of those products is a living annuity, which, again, can invest in unit trusts. And, again, you will have the benefit of not paying any tax on profits you make inside the investment.
  
  A living annuity, must, however, pay out an income every month. This must be between 2.5% and 17.5% of your total per year. You will pay tax on that income at normal tax levels.

• Endowment
  
  An endowment is a more complicated kind of investment that could also use unit trusts, but has flexibility to invest in many other assets as well. One of its features is that you will only have limited access to the investment for the first five years.   
  
  It can also carry a tax benefit, in that tax on profits during the investment period will always be paid at 30%, and no tax will be paid at the end. For investors whose marginal tax rate is higher than that, this can be an excellent benefit.

• Preservation fund  
  
  Under current regulation, anyone who changes jobs and therefore leaves their employer’s retirement fund has three options: you can have the money paid out, with severe tax penalties; you can keep the money in the fund; or you can move the money to a preservation fund.  
  
  Essentially, these funds work the same as retirement annuities, and there is no need to make any further contributions. Your money will continue to grow tax free until you reach the age of 55, at which point you have the same options as for a retirement annuity.

Take professional advice on which of the different investment options are best for your particular needs.