The value of establishing robust investment foundations early on

There are a plethora of quotes about starting to invest as early as possible but, while this is certainly a crucial factor, doing so requires first having an understanding of which asset classes and product types to invest in.

Choosing asset classes suited to your needs

A quote by Robert G Allen sums up why investing in the correct asset class is important: “How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.”

When considering what asset classes to invest in, investors need to consider the outcomes they need their financial plans to deliver as well as the time horizon within which those outcomes should be achieved. For example, choosing a low-risk asset class may result in financial goals not being achieved because the returns over time typically associated with these assets will not be high enough.

Another critical factor when considering asset classes is the investor's appetite for risk. While being in an investment portfolio allocated to equities has historically given investors the best returns over the long term, investing in this asset class has also historically come with a lot of volatility, which some investors may not be able to stomach. If your appetite for risk is lower than the risk typically associated with the asset class you choose to invest in, this mismatch may cause you to make decisions that could negatively impact your financial goals – such as wanting to withdraw or switch out of certain asset classes during periods of market volatility.

Making sure that you select the correct asset classes in the correct proportions is a delicate balance, and one that is important to get right to achieve your desired financial outcomes. A skilled financial adviser can help you to navigate these considerations optimally to help you reach your financial goals.

Selecting suitable products

While certain products provide benefits that can offer tax relief, these products may not necessarily provide a younger investor with the flexibility that they are likely to require as their needs change. When considering what products to invest in, the tips below can serve as a yardstick for young investors.

Establish a reserve that can cater to the critical next stages of your life

A discretionary investment like the PSG Wealth Voluntary Investment Plan is a great option for young investors as it offers significant flexibility, including being able to access investment savings when required. It is also a useful savings vehicle if you have a specific savings goal in mind, for example when saving for a deposit on a car or your first home.

Retirement annuities and tax-free investments

Once you have established such a reserve, retirement annuities (RAs) and tax-free investments (TFIs) can be a formidable combination to consider adding to your investment portfolio. While there are scenarios where an investor can benefit from investing in one of these products and not the other, the reason I note that they can be a formidable combination is that each product has its own unique benefits (some of which are explored below), and investing in an RA as well as a TFI can offer investors the best of both worlds.

• While the returns within both RAs and TFIs don't attract tax consequences, an RA – such as the PSG Wealth Retirement Annuity – provides additional benefits in this regard because the contributions to an RA reduce taxable income and ultimate tax liability.
• Funds invested in a TFI are more accessible if such a need arises as these products allow you to withdraw your funds at any time. However, keep in mind that there is a lifetime limit of R500 000 that you can contribute to TFIs, and if you withdraw funds from this type of product and reinvest them later this will count as an additional contribution towards the lifetime limit. Not only can you not simply recontribute withdrawn amounts but, as a result of this, withdrawals from a TFI can also negatively affect the benefits of compound interest on your TFI in the future. In terms of withdrawals from RAs, the introduction of the two-pot retirement reforms means that from 1 September 2024, members of retirement annuity funds will be able to withdraw one third of their RA contributions each tax year.
• Turning to the asset classes you can choose to invest in within each of these products, TFIs – like the PSG Wealth Tax Free Investment Plan – are generally more flexible. For example, TFIs can invest 100% in equities, while RAs have a 75% limit. If you make the correct use of the TFI’s increased asset class flexibility, there is the potential that this could lead to higher returns over the long term.

So, after establishing your reserve for those important life events, should you go for an RA or a TFI first? The simple answer is that this decision will depend entirely on your unique circumstances. One consideration is your tax bracket (RAs provide more relief). It will also depend on when and how frequently you will need access to your investments (TFIs provide more flexibility), what asset classes you want to invest in (TFIs generally offer more flexibility), and whether you will need protection against potential future claims from creditors (which RAs provide).

Your unique needs and circumstances will determine how much you should contribute to your RA and how much you should contribute to your TFI. The fact that these will differ from one person to the next is but one reason why it is advisable to consider speaking to a skilled financial adviser, who can help determine your needs so that you can make sound decisions on product and asset class choices to give you the best chance of reaching your financial goals and objectives.