Stealthy Wealth

How Much It Cost Us To Emigrate To The UK

2021-09-07T06:54:00.007+02:00

The most expensive flight of my life

Now that the dust has finally settled on our move to the UK, and most of the whirlwind of admin that goes with packing up and moving to a new country (and then thrown in for good measure – a new job, a new house and new schools, all while in the middle of a global pandemic) things are finally starting to go back to some semblance of normality.

That means I finally have a little bit of time to sit down and take stock of the move, and in particular dig a little bit into something a few of the readers have been asking – just how much does it cost to emigrate from South Africa to the UK?

Of course it is impossible to give a generic answer, and naturally the cost will vary from person to person and from family to family. But in this post I will lay bare the numbers involved in getting myself and my family (1 x wife, 2 x kids (aged 1 and 4)) from sunny South Africa to the er…let’s say… the not so sunny United Kingdom 

Right, I am armed and ready with pretty much all the bank statements, invoices and receipts related to our emigration.

But before we start, I must mention that some of the costs we needed to pay were in Rands, while some were in Pounds. Now, I am guessing the majority of this audience are of the ZAR variety, and so I will convert any £ related expenses back to Rands using an approximation of R20 for £1 (which is around what the exchange rate was at the time of our emigration).

Of course this exchange rate changes all the time and so it is just an approximation. If the Rand weakens you may need to pad the below numbers a little bit, and if the Rand strengthens you may need to trim them a little.

Okay, let’s go!

Transport – R25,782

Perhaps the most obvious cost of getting to a new country is, well….er…. getting to a new country. For us this ~~monstrous 24 hour endeavour with 2 kids in tow~~ delightful and leisurely journey consisted of 2 trains, 3 flights and 2 taxis.

Of course, your transport cost will vary depending on how many of you there are, the time of year, where you are coming from, where you are headed, and the number of stopovers (we ended up with 2 stopovers as the flight times worked well with sleep and nap times for the kids).

Oh and don’t forget to book one way 

The breakdown of the cost for getting me and my family to the UK:

Flights	R24,100
Trains	R200
Taxis	R1,482
	R25,782

Moving Furniture – R97,695

Once the cost of getting yourselves over to the UK has been covered, you may want to look at the cost of getting your stuff over to the UK.

There are a number of ways to approach this, with some people advocating that you shouldn’t take any of your possessions, while others say it’s nice to have your own furniture and familiarity in a new country. And then there is every shade in-between those two extremes.

I was in the extremely fortunate position that my new company gave a relocation allowance which could be used to offset the cost of shipping our stuff over. And so we opted to bring just about everything over (although we did end up selling a fair amount of items before the move).

Broadly speaking, there are two options when it comes to shipping containers – you can book an entire container for yourself, or you can book part of a shared container (and only pay for the space you use).

The shared container option can be more cost effective, but it comes with some additional uncertainty around when it will leave South Africa (they generally need to wait for a container to fill up before they load it onto a ship heading for the UK). So your container may sit in SA for a while while they wait for the rest of it to fill up. (Hey I never knew it was possible to use two consecutive while's in one sentence!)

With a dedicated container, the departure date is set and it can make the delivery date of your possessions a little more predictable (although still not exact).

In addition, there is a certain point where if you fill up a shared container enough, the price becomes pretty comparable with the cost of a dedicated container. We always asked for quotes for both the shared and dedicated container options, to compare. In our situation the cost of the dedicated container came in only a little higher, and with the more certain arrival date it seemed like the better choice for us.

Shipping Container	R97,695
	R97,695

Passports And Other Documents - R18,139

I was the lucky winner of having a passport expire during the first lockdown in March last year. A few months before March, I had booked and managed to secure a passport renewal date. With my appointment about a week away, lockdown struck and I was unable to get get the renewal done.

Fortunately some of the restrictions were lifted over time and I was able to find an agent that could get me an appointment at home affairs based on exceptional circumstances (my new job was dependent on me getting a passport). It delayed our eventual departure a little, but I was glad I could at least get it done.

My wife also needed to renew her European passport (she and the boys would be using the EU route to get into the UK – it was a lot cheaper that way). I also needed to organise passports for our two boys (both European and South African.)

As I’m sure you can imagine all of this was a lot of fun with minimal stress!

My VISA also required me to have a TB test, get my qualifications recognised in the UK and prove I was competent in English (unfortunately a couple hundred blog posts don’t count ) – all of which had their own charges.

Passports	R9,691
TB Test	R2,500
Supporting Documents	R5,948
	R18,139

Visa - R58,560

As mentioned before, I was going to be heading over on a skilled worker Visa, while my wife and the kids were going on a EU passport. The costs of Visas vary greatly depending on your circumstances and the duration of the Visa. I went over on a 5 year Visa, which currently costs £928 per person.

My type of Visa (as well as some of the other types) require you to pay an upfront health surcharge. This reason for this charge is to “ensure that temporary migrants make a fair and appropriate financial contribution to the NHS (National Health Service) as well as to prevent medical tourism and unfair use of health services in the UK.

The current cost of the health surcharge is £624 (around R12,480) per year, which is up pretty heavily from the £400 (around R8000) per year charge when I applied. I get the feeling this charge it is probably going to increase even more going forward. You must then multiply this per year cost by the number of years your Visa will allow you to stay in the UK. It's pretty heavy (with ours clocking in at R40,000)!

Visa	R18,560
Health Surcharge	R40,000
	R58,560

Accommodation - R59,200

Living somewhere new is best when you have somewhere to live!

The approach we took in sorting out our accommodation, was to first book a short term rental/long stay guest-house for the first month or so. From there we could look at getting something more permanent.

Two reasons we did it this way:

To allow us to view properties and areas before committing to a longer term rental (in addition we were finding it incredibly difficult to get any rental agents to get back to us on the enquiries we made from South Africa. Based on the 2 or so replies we did get, it seemed like in the part of the UK we were moving to, you kind of needed to be in the country before anyone would even consider you).
It would allow some time for our container with our furniture to arrive. Getting a place and having our furniture arrive at the more or less the same time would reduce the time we would be sleeping on blow up mattresses (it feels like camping and is kinda fun for the first night or two, but after that not so much).

We managed to find really nice 2 bedroom, furnished apartment that would have us sorted for the first month and a bit at a cost of £1260 (around R25,200). Now I must mention that this figure is definitely on the very low end by UK standards since we were (and still are) in one of the cheaper areas of the UK. For other parts of the UK (like e.g. London) I would not be surprised to find something similar would cost double or even triple what we paid.

In that first month, and with many of rental agencies not at full operating capacity due to Covid, it was really tight toward the end - but we managed to secure a more permanent rental just in time. Now even though our rental cost from this point onward is not really a cost of emigration, I am mentioning it here because there are many places which require 2 or sometimes even 3 months deposit to secure it.

The rental market in the UK works quite different to South Africa in that you have many people “applying” to rent a place, and then the landlord decides who they like best based on current job, previous rentals, how much deposit they have etc. Since we weren’t from the country and didn’t have any previous UK rental record, we needed to offer 2 months rent as a deposit to sweeten the deal.

The rent for the place we wanted was £850 a month, so our deposit ended up being £1,700 (around R34,000). Again I must mention that this is in one of the cheaper areas of the UK and you could probably double (or even triple) that rental and deposit cost for a similar family-of-4-type accommodation in other parts of the UK.

1 Month Short Term Furnished Rental	R25,200
Rental Deposit	R34,000
	R59,200

Adding It All Up

Right so let’s put everything together… Get the calculator out..

Our total bill for emigrating from South Africa:
R259,376

Wow, seeing this number is pretty scary – over a quarter of a million!

But to put it into perspective - that money would only get us around 2 years worth of medical aid contributions and school fees had we stayed in South Africa. So it's all relative I guess. And I am just really grateful I didn't have to foot the entire bill. My then future and now current employer, very generously covered around 80% of our total cost through their relocation allowance.

And of course it is possible to do it cheaper. But yes, there is no two ways about it - emigrating is pretty costly!

Other Expenses To Think About

Keep in mind that not everything in our list of expenses will be applicable to everyone. But in the same breath, there are also expenses which were not applicable to us that other people would incur. For example, getting pets over can be pretty expensive.

Update - one of the readers pointed out that I had forgotten about the costs of staying in a quarantine hotel if you arriving from what the UK calls a "red list" country. As it currently stands, South Africa is on this list, and so you will need to fork out a pretty hefty sum for the privilege of being locked in a hotel room for 10 days. We were fortunate that there was only a self isolation requirement when we made the move over.

The Hidden Costs

Sitting here with a list of receipts and bank statements, it is pretty easy (although slightly more tedious than I first thought) to flesh out all the numbers around the cost of our move. And that’s because those costs are pretty obvious and visible.

Unfortunately there are a whole hosts of other costs, which although not as visible, are still very much there.

These can be difficult to put a figure on, but it is important to realise that we also lost quite a bit of Rands on things like:

Selling our house (and the additional costs and taxes if buy again on this side)
Selling and rebuying a car
Cashing out pension funds
Selling out of investments and re-buying them on this side
Selling/Donating/Scrapping furniture/household items and rebuying them on this side

And yes some of these may not be applicable to everyone, but then again there are other similar hidden expenses which weren’t applicable to us but could be to others.

Although I Am Now Experienced, I Am Not An Expert

I suspect that after this article I am going to be getting a lot of questions and queries about Visas, landing jobs in the UK, and eligibility for getting into the UK.

Unfortunately a lot of the answers to these questions are very dependent on each person and circumstances, but I will try give some more info and useful links below as a starting point.

For skilled worker Visa info, you can check out this Gov.UK link https://www.gov.uk/skilled-worker-visa . In fact, the Gov.UK website has really great info on all types of Visas, eligibility and all the processes involved. It was my go to resource for our emigration and I highly recommend it (as opposed to checking out what Ben has to say on that other Facebook group. Although I must say, there are some pretty decent Facebook Groups with knowledgeable people and really good information. But never just believe everything you see on the socials - official information is best.). There are also professional immigration lawyers which you can make use of – some of them will even help with initial information for free.
For jobs, there are a few good websites. Top of my mind is reed.co.uk, but keep in mind that there may be better sites for certain industries/levels of experience etc. I ended up on a few recruiters radars after submitting my CV to a couple of UK job sites and making some applications. Then when a recruiter got in touch. I was able to explain that I would be needing a Visa to emigrate, and so I could only consider companies who were willing to sponsor me.

Till next time, Stay Stealthy!
- ~ - ~

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A Collection Of Personal Finance Cheat Sheets

2020-11-10T07:06:00.007+02:00

Crib notes!

Over the years I have generated a number of 1 page summaries and explainers related to personal finance and investing. That's because sometimes a picture or an infographic can explain things in way that is a lot easier to understand. Sometimes the different angle allows a concept to stick.

Nah, who am I kidding - people just don't like reading! :)

Anyways, I figured now might be a good time to put all these 1-pagers together in one place. So if there are any newcomers who may have missed some of them, you can now catch up.

And of course, for the Stealthies who have been around for a while, you can now binge watch the entire Season 1 of Personal Finance.

Here's a list of the episodes:

1. How to achieve financial freedom
2. Asset Classes
3. ETFs
4. TFSAs
5. Investing jargon buster
6. IDEAS to get your finances in order
7. How Tax works
8. RAs vs TFSAs
9. Successful investing

(Note - all images can be clicked to view a larger version)

How To Achieve Financial Freedom

Here is how to put a financial freedom plan together

Asset Classes

A cheat sheet of the 4 main asset classes

ETFs

ETFs (Exchange Traded Funds) in a nutshell

TFSAs

TFSAs (Tax Free Savings Accounts) in a nutshell

Investing Jargon Buster

An explanation of some of the more common terms you will come across in the investment field.

IDEAS To Get Your Finances In Order

Want to improve your finances? Here are some IDEAS.

How Tax Works

How the main types of Tax work.

RAs vs TFSAs

Similarities and differences between Retirement Annuities and Tax Free Savings Accounts.

Successful Investing

The 4 Ps of successful investing

I hope you find some or all of these useful! Feel free to share them with anyone who you think would benefit (or who doesn't like to read :-P)

Till next time, Stay Stealthy!
- ~ - ~

The Ultimate Retirement Annuity Guide

2020-10-29T07:33:00.007+02:00

Get some coin!

*Updated - September 2021

We all hope to have enough money to pay for our monthly expenses (and some extra for fun stuff of course) once we hit retirement. No one wants to eat dog food 3 times a day. Except your dog of course. But I digress...

Retirement Annuities are one of a number of different products designed for the sole purpose of helping you achieve financial freedom in retirement.

And because having enough money in retirement means that the Government doesn't have to look after you, many of these retirement products also come with some really nice tax breaks. Think of it as the Governments way of saying thank you for looking out for your future.

In this easy to follow guide, we are going to be looking at everything Retirement Annuity. We will start with the basics, and then cover some of the advanced topics too.

You are going to be a Retirement Annuity guru in no time!

What Is A Retirement Annuity (RA)?

A lot of people are under the impression that a Retirement Annuity (or RA) is a mystical and complicated beast which only the experts fully understand. The pros love to throw jargon around, and this means many people lose interest pretty quickly and believe they will never understand what an RA is or how it works.

So let's dumb it right down, because a RA is actually pretty easy to understand.

A Retirement Annuity is basically a... bucket.

Wait, what?

Yup an RA is like a bucket. And on it’s own it doesn’t do much – that is until you put some stuff into the bucket. It’s kind of like a bank account is just a number, but it becomes useful once you put some money inside of it.

So what can you put inside of an RA?

Well, to continue with the bucket analogy, you can put some investment blocks inside of your RA bucket.

These investment blocks are pretty much just like any other investments – Unit Trusts, Cash, Bonds etc.

To really dumb it down, it looks a little something like this - just a bucket with some blocks in it...

Now the reason you want to put your investment blocks inside of an RA bucket, is because once inside the RA bucket, these investment blocks enjoy some pretty awesome tax breaks. You do not pay Income Tax, Capital Gains Tax or Dividends Withholding Tax inside of an RA.

And there is another great tax benefit to Retirement Annuities - you do not pay any tax on the money you contribute to a RA. The cool kids will tell you that contributions to a RA are "tax deductible" (more on that in the next section)

That is why many people use retirement annuities to save for their retirement – by not paying tax on your contributions or on your RA investments, it means you come out with more money when you retire. More money is good.

So as you can see, the product is not maybe as complicated as many would have you believe?

Before moving on, let's quickly summarise what an RA is

RAs In a Nutshell

Retirement Annuity meaning - A RA (Retirement Annuity) is basically a retirement savings account which holds some investments. The investments inside of an RA can be in the form of Unit Trusts, ETFs, or even Cash.

The reason you would want to put your investments inside of an RA are due to the tax protection you get by holding them inside of an RA and because the contributions you make to an RA are tax deductible.

Retirement Annuities v Unit Trusts

Many people confuse Unit Trusts and Retirement Annuities, and that's probably because the two are often used together. However there are some pretty big differences between the two which is explained below.

Unit Trust	Retirement Annuity
A unit trust is an investment product which you can buy. Depending on the type of Unit Trust, your money will be invested into one or more asset classes (Cash, Bonds, Equities, Property or Commodities). Unit Trusts spread your money (by investing in different asset classes, or countries, or in different companies) meaning that your investment is diversified	A retirement annuity is just a bucket, which by itself doesn’t do anything. To turn a retirement annuity into something useful, you need to put something inside the bucket. The investments you put inside are then protected from Tax. One of the things you can put inside your Retirement Annuity bucket are Unit Trusts

A good way to visualise the difference between an RA (Retirement Annuity)and a UT (Unit Trust) is to think of them as a chocolate (Yum!)

The RA is the chocolate wrapper (which protects the chocolate from dirt, keeps it fresh and stops the Government from eating some of it (Tax)). When people talk about Retirement Annuities, they mean the wrapper. But remember, a wrapper by itself is just a wrapper - we want the goodness inside!

A Unit Trust is an example of some of the deliciousness you can find inside of a RA wrapper. The other types of chocolates include ETFs or cash savings.

Tax Treatment Of Retirement Annuity Contributions

There is no tax payable on the investments inside of a Retirement Annuity. And that’s a really great feature. But there is another great tax benefit related to contributions you make to a Retirement Annuity.

Retirement contributions are what is called tax-deductible. In short that means that you do not pay tax on the money you invest into a Retirement Annuity.

In the view of SARS, you only earned (and therefore are only taxed on) the money you receive after you subtract (or deduct) the contributions you made towards your retirement annuity .

Tax treatment of your RA contributions looks a little something like this

For example, if you earned R250,000 for the year, but you contributed R1000 a month to a Retirement Annuity (which is R12,000 for the year) you will only be taxed on R238,000.

Because the contributions to an RA are tax deductible, it is like you earned less, and therefore you pay less tax. Less tax is good!

Maximum Tax Deduction

The RA contribution tax deduction can really work in your favour. But SARS generosity does have a limit...

There is a maximum amount you are allowed to deduct from your taxable income with regards to retirement contributions (and note that this maximum applies across all retirement product contributions including your company’s pension or provident fund as well as retirement annuity contributions).

The current legislation states that you can deduct a maximum of 27.5% of your remuneration or taxable income (whichever is higher), and no more than R350,000.

This is best explained using some examples.

First let’s assume Daniel earns R400,000 a year and wants to work out the maximum he can contribute to retirement savings products.

Maximum Tax Deductible = Taxable Income x 27.5%
= R400,000 * 0.275
= R110,00

This means that Steve would be able contribute a total of R110,000 per year (or R9167/month) to a pension fund, or RA, and deduct this from his taxable income for the tax year.

Instead of being taxed on earnings of R400,000 for the year, he would only pay tax on R290,000 (R400,000 - R110,000).

As another example, meet the future you earning a cool R1.5Million a year. Let’s calculate the maximum tax deduction you would be allowed.

Maximum Tax Deductible = Taxable Income x 27.5%
= R1,500,000 * 0.275
= R412,500

In this scenario, the 27.5% of taxable income gives R412,500. But we must remember that there is a cap of R350,000 on the amount you are allowed to deduct.

Because of future you’s supersized earnings, the R350k cap is breached (lekker problem to have!) and so the maximum tax deductible contributions is limited to R350,000 worth of contributions per year (or R29,167/month) to a pension fund or RA.

Retirement Annuity - Minimum Investment Amount

Some RA providers require you to have either a minimum monthly amount, or a minimum lumpsum amount available to invest before they will let you open a RA with them.

For example a RA provider may stipulate that you need to invest a minimum of R500/month or have a lumpsum of R10,000.

For some people this may seem pretty steep. But fear not!

There are some providers which have no minimums, and they will allow you invest even R10 at a time. For example there are no minimum requirements if you invest in the EasyEquities RA.

Retirement Annuity Investment Rules

So, as we have seen from the above, SARS is pretty generous in allowing your contributions to be tax deductible, and also allowing the investments inside of an RA to grow tax free.

But nothing for nothing right?

So what is expected from you in return?

Well there are a few rules regarding the investments inside a Retirement Annuity. The legislation, or rules, around what is and isn't allowed for the investments inside of a RA is known as Regulation 28.

Regulation 28 has quite a local is a lekker approach, and so the first rule it imposes is that no more than 25% of your investment is allowed to be outside of South Africa.

You are allowed an additional 5% outside of South Africa, provided it is being invested into Africa. This takes the maximum amount of the investment allocated outside of South Africa to 30%. So all in all at least 70% of your RA needs to be allocated to South Africa.

Your investments inside of an RA are also limited in terms of which types of asset classes you can invest in. The main types of asset classes are: Equities (companies), Property, Bonds, Cash and Commodities.

Currently Regulation 28 says that you cannot have more than:

75% invested into equities
25% invested into property

Retirement Annuity Fees

It is vitally important to keep an eye on the fees you are paying/are going to be paying on a RA.

Paying too much for a Retirement Annuity can undo all the hard work you have put in and the sacrifices you have made in order to afford your RA contributions.

Bear in mind that most RAs are targeted at growing a certain percentage above inflation. That percentage above inflation is what is known as your “real return”. The real return is the part that makes your RA grow, and it is the part which makes you wealthier.

If you are not beating inflation, then you are not going anywhere (or you may even be going backwards!)

Now if, for example, your RA generates a return of 3% above inflation, but you are paying 3% in fees, then you have not gone anywhere. You have not generated any wealth.

Paying a reasonable fee for your RA is super important.

What Makes Up The Total Cost Of A RA?

When it comes to assessing the total fee that you pay for an RA, you need to consider each component of the RA you have signed up for/are going to sign up for.

To understand the various components it is probably best to revisit the bucket analogy for RA’s (from the beginning of the article.)

Remember an RA is like a bucket with some investment blocks in it.

When you consider the total fees of an RA, keep in mind that there is usually an annual fee for the “Bucket”, and then there is also a fee related to each "Investment Block" in the bucket.

And if you signed up for your RA through a financial adviser, you can be sure that they are taking their cut every month as well.

The total fees look a little something like this:

So the three main components which make up the total fees you pay are:

The RA platform/admin/annual/account fee(s) (a.k.a. Bucket Fees)
The underlying investment fees (a.k.a. Investment Block Fees)
The financial adviser fees (if you used one to sign up for the RA)

How to find out your total fee

Figuring out exactly how much you are paying for your RA can be tricky business. Different providers call their fees different names, and sometimes you don’t even know what the underlying investment blocks are, never mind what they cost.

If only there was a single figure which could represent the total annual cost that you are paying/will be paying for an RA? That way you could easily compare options, and figure out pretty quickly if you are being ripped off?

Well luckily there is!

The EAC (Effective Annual Cost) is pretty much a single figure which represents all the costs related to an RA. This makes it easy to compare RAs – e.g. RA x with an EAC for 1.6% is cheaper than RA y with an EAC of 2.5%.

So if you want to know the total cost of an RA, send your RA provider or financial adviser a mail and ask them to send you the EAC (or alternatively check your RA statements).

Tips For Reducing Retirement Annuity Fees

Bucket Fees – This fee can be called many things – admin/annual/account/platform fee. It is basically the fee the RA provider charges for your RA. Some providers are more expensive than others (but may provide additional features like access to particular Unit Trusts or ETFs), and there are even providers who charge a 0 bucket fee.

If you consider that most RA’s aim to achieve the same thing – to grow your money for retirement by investing in asset classes that are suited to your goals, time frames and risk appetite, then it make sense that a lower cost RA provider will leave you better off.

Investment Block Fees – The investment blocks inside of the RA bucket is what is actually growing your money (remember the RA account (bucket) only offers you the tax benefits and implements the regulation 28 rules). The investment blocks would have been selected by you or your financial adviser to give you exposure to different asset classes (cash, bonds, property, equities) according to your goals, time-frames, risk appetite personal preference etc.

The chosen asset allocation is often implemented through Unit Trusts or ETFs. Now if you consider that ETFs have fees of around half that of Unit Trusts, it means that on average, the average investor would achieve a better outcome (and yes, there is research to back this up) by choosing ETFs instead of Unit Trusts in their Retirement Annuity.

Financial adviser fee – There are generally two types of financial advisers, those that charge a percentage based commission and those that charge a flat fee/hourly rate. A financial adviser who charges a percentage based commission will take a cut for every month that you have the RA. In the beginning this can be pretty cost effective, but as your investment grows larger, the fee that the financial adviser charges also grows and can easily run into tens of thousands of rands a year for larger investments.

For large investment balances it can be more cost effective to pay an adviser a fixed fee or an hourly rate instead of a percentage based fee

And of course, many of the RA providers allow you to sign up directly. If you know your risk profile it is possible to skip a financial adviser and sign up directly (but note this option is best suited for more experienced investors who have some investment knowledge.)

The Best Retirement Annuity

Naturally, when signing up for a Retirement Annuity, you want to choose the best one. But before we try pick the best RA, maybe we should define what exactly we mean by “best”.

To me the best RA would be the one which gave me the most money at the end.

Not so?

Maximising your investment is the whole point of trying to make sure you pick the right RA.

So the next question is - What are the factors which influence the final investment amount?

In my mind there are two (ignoring the number of years invested and the contribution amount because that would be the same no matter which RA you went with).

Therefore the two factors which will affect the final investment outcome of your RA are:

Fees
Investment performance

Let's unpack these.

Fees

Yes, I know, we are back at fees again. And maybe you starting to appreciate how important they are (and if not yet, then definitely soon - keep reading)

We already looked at some tips for getting the fees of your RA down. So why would you want to do this?

Well quite simply, the less of your investment you pay away in fees, the more of your investment is left in your account to grow and compound.

It might not seem like fees are that big a deal, but have a look at this picture courtesy of 10x

Fees continuously nibble away at your investment, resulting in you having significantly less than what you could have had (in the 10x example above, a whole R1.9 Million less if you pay a 3% fee instead of a 1% fee!)

It may seem like some effort to shop around and compare RA options, but if that leaves you a few million better off it is well worth it! Surely?

Okay, so that covers the fee aspect of the RA outcome - less if more!. Let's check out the other important factor.

Investment Performance

The other important factor which determines how much you end up with in your RA is investment performance.

There is no escaping the fact that different investment blocks in your RA bucket will perform differently. Some will give spectacular returns, and some will be epic disasters.

No problem though – all you need to do is make sure that you fill your RA bucket with only the best performing blocks. Easy peasy.

If only.

The big problem is that there is no way of telling which blocks will perform the best.

Research confirms that past performance is a pretty useless indicator of future performance. however what research did find is that there is only one factor which is slightly correlated to future performance.

Any idea what it is?

It starts with an F...

Yes that's right, we are back to fees!

Investments with lower fees tend to outperform those which charge higher fees – irrelevant of past performance.

So the two factors which affect the outcome of your RA investment (fees and investment performance) can actually be reduced to only one factor – Fees

In other words, one way of selecting the best RA would be to just select the cheapest RA.

The Best Cheapest RAs In South Africa

This really awesome online tool ranks the cheapest RA providers according to the fees that they charge. Currently it lists these 5 providers as the cheapest in South Africa* (not necessarily in order)

Sygnia
Nedgroup
Easy Equities
10x
Outvest

(*There may be others and this list is subject to change )

Note that some providers fees change depending on your investment size, and so the total cost can vary according (yes size usually matters!)

If you want to keep your RA fees low, you will do really well to start looking into the above providers.

Accessing Your Retirement Annuity

Generally speaking, you can only access the funds inside of a retirement annuity once you are 55 years old (there are some exceptions – like emigration (more on that later), using the funds for a divorce settlement, if you suffer a disability, or if the value in your RA is less than R7,000).

This means that when you invest in a retirement annuity, you are effectively locking your money away until 55.

Then, once you are 55 years old, there are some rules around what you can and cannot do with the funds in your Retirement Annuity.

Retirement Annuity Withdrawal Rules (2020)

Once you are 55 years old you are allowed to “retire” from your Retirement Annuity. There are however some rules around the amount of cash you are allowed to take, and what the remaining money needs to be used for.

In short the rules are shown in the picture below. A more detailed explanation follows after.

You Can Take Up To 1/3 Of The Value Of Your RA As Cash

If the total value of your retirement annuity is less than R247,500, then you are allowed to take the entire value of cash.

If you have more than R247,500, then you are only allowed to take up 1/3 of the value as cash.

For example, if your Retirement Annuity is worth R1.2 Million at age 55, you will be able to take up to R400,000 as cash.

Note that the cash lumpsum that you take is subject to tax according to the rates specified in the table below (These values are for the 2020/2021 tax year, are available on the SARS website, and are subject to change going forward.)

Taxable income (R)	Rate of tax (R)
1 – 500 000	0% of taxable income
500 001 - 700 000	18% of taxable income above 500 000
700 001 – 1 050 000	36 000 + 27% of taxable income above 700 000
1 050 001 and above	130 500 + 36% of taxable income above 1 050 000

As an example, consider someone with a RA value of R1.8 Million.

At age 55, they are allowed to take up to 1/3 of this value as cash (R600,000). If they decide to take the entire 1/3 (R600,000) as cash, then they will be taxed according to the second row of the table above, and they will pay 18% of the amount above R500,000

Tax payable = 18% of R100,000
= 0.18 x 100,000
= R18,000

So they will pay tax of R18,000 and end up with R582,000

Next consider someone with a Retirement Annuity value of R3 Million. At age 55 they will be allowed to take up to 1/3 of the value as cash (1 Million). But say that they elect to only take R800,000 as cash.

The third row of the table applies, and they will pay tax of R36,000 plus 27% of the amount above R700,000.

Tax payable = 36,000 + 0.27 x R100,000
= 36,000 + 27,000
= 63,000

So on the R800,000 lumpsum they will pay a total of R63,000 in tax, and end up with R737,000

Note - you are allowed to take a maximum of 1/3 of the value of the RA as cash, but you are not obligated to do so. In other words you are allowed to take less than 1/3 as cash, or even no cash at all.

Possible RA Cash Hack

If the value of your RA is less than R247,500, then you are allowed to take 100% of the value of the Retirement Annuity as cash, and you do not need to buy any living or guaranteed annuity products with the proceeds. But there is a caveat to this law which allows for a possible hack.

You see the R247,500 threshold applies per RA registered fund, not per individual policy or contract.

In practice, this means that if for example you had 3 different Retirement Annuity policies, all the with same provider, and each policy was worth less than R247,500, but together they exceed R247,500, then you would not be able to take 100% as cash.

But....

Say for example, you had two different Retirement Annuity policies with two different providers, and each policy was worth R220,000. In this case you would be able to take R220,000 out of each RA as cash, and end up with R440,000 cash.

Of course multiple RA policies require additional admin, but this is something to keep in mind if your RA is not expected to be very large, and you would like full access to cash once you retire from the RA.

The Remaining 2/3 Must Be Used To Buy An Annuity Product

So if you are only allowed to take a maximum of 1/3 as cash when you retire from your Retirement Annuity, what happens to the other 2/3?

Well, you need to use that money to buy yourself an Annuity Product. This annuity product is designed to pay you a monthly income.

In short there are two types of annuity products you can buy with the remaining 2/3 of your Retirement Annuity value. You are allowed to buy either one or the other type, or even a combination of the two.

A guaranteed annuity – This is an insurance product which will pay you a guaranteed monthly income until you die. Depending on the options you select, you can have the monthly amount increase according to inflation each year, or remain at the same level (in which case your income will buy you less and less as the effects of inflation slowly reduces the purchasing power of your monthly income.) You can also select different options relating to whether the income should go to your surviving spouse once you die. With this option you will not be able to leave anything to your beneficiaries.
A living annuity – This is an investment product which you can draw a percentage from each year in order to cover your living expenses. Unlike a guaranteed annuity which pays you every month until you die, if you draw too much out of a living annuity you could run out of money. If you die and there is still money left in your living annuity, you can leave it to your beneficiaries.

Note that the income that you take from either a Guaranteed or a Living Annuity is subject to income tax.

Retirement Annuity vs Pension Fund

A Pension Fund and a Retirement Annuity are both products which can be used for saving for your retirement. They also enjoy many of the same tax benefits and are subject to the same Regulation 28 rules which govern all retirement savings products.

In other words Pension Funds and Retirement Annuities are very similar, and everything in this article around the tax treatment and rules of investing in an RA also applies to pension funds. A pension fund can be accessed before age 55 (but there are tax penalties if you do this) whereas generally speaking a RA cannot.

Another big difference between a pension fund differs and a RA is that you can only join a pension fund through the company that employs you.

If you become employed by a company that offers a pension fund, and you are eligible to join, then in most cases you are obliged to join the fund and it will be a condition of your employment. Your contributions to the fund will be automatically deducted and reflected on your payslip.

Because your pension fund is tied to your employer, it means that if you resign, are fired, or you are retrenched, you can no longer remain a member of the fund. In this case there are a few options you can consider for the money in your pension fund. You can:

Preserve your money in a Preservation Fund,
You can take a partial or full cash withdrawal (which will be subject to tax and IS NOT recommended if you can avoid it.)
If you are moving jobs, and your new employer’s pension fund is with the same provider as your previous employer, then there may also be an option to transfer your pension fund to the new employer.

If you are a member of your employer’s pension fund, you will still be able to open an RA in your private capacity. Just remember that the retirement contribution tax deduction applies across all retirement products.

The similarities and differences between Pensions Funds and Retirement Annuities are summarised below.

Emigration And Retirement Annuities

Legislation states that the funds in a Retirement Annuity cannot be accessed until the age of 55. However, one of the exceptions to this rule is if someone has emigrated from South Africa.

The Income Act states that if a South African citizen has formally emigrated from South Africa (that is to say you have physically emigrated) and the emigration has been recognised by SARS, then they will be able to access the funds in their RA, subject to tax.

In short, for SARS to recognise your emigration, you need to financially emigrate.

In order allow your RA provider to pay out the value of your RA, they will need to submit a request to SARS so they can obtain a tax directive for the full value to be paid out in cash due to financial emigration. To allow them to get the tax directive, the RA provider will require you to submit the following:

Attested MP336(b)
ETCC
SARB approval
Tax residency certificate (to show the country where you are currently residing)
Latest SA bank statement (to show that you have an open an active SA bank account.)

You will notice that in order to withdraw from your RA upon emigration, you will still need a South African bank account.

The reason for this is that the RA pay-out cannot be sent directly to a foreign bank account. The funds need to be paid into a local South African bank account which is in the name of the RA policy holder (so you also will not be able to use Aunty Sue’s bank account and then ask her to send you the money).

In case you were wondering, it is possible to hold a South African bank account even if you have financially emigrated. The bank accounts status will need to be updated to a non-resident bank account.

Once the money is in your non-resident South African bank account, you will then be able to transfer it to your bank account in your new country.

Tax On Retirement Annuity Pay-outs Due To Emigration

It is important to note that when making a full withdrawal from your RA due to emigration, the pay-out is subject to Tax. The amount of tax charged is dependent on the size of the withdrawal.

The table below (available on the SARS website) specifies the tax payable upon RA withdrawal for the 2021 Tax Year (Note that this table is usually updated in the annual budget, and so it is subject to change going forward)

Taxable income (R)	Rate of tax (R)
1 – 25 000	0%
25 001 - 660 000	18% of taxable income above 25 000
660 001 - 990 000	114 300 + 27% of taxable income above 660 000
990 001 and above	203 400 + 36% of taxable income above 990 000

As you can see the first R25,000 of the RA pay-out will not be taxed. Any amounts above R25,000 start attracting tax at 18%.

For example, if someone cashes out a RA worth R500,00, then the second row of the table applies. They will be charged 18% of the value above R25,000 (which is 18% of R475,000).

Tax payable = 0.18 x R475,000
= R85,500

This means they will end up with R500,000 – 85,500 = R414,500

As another example, if someone has an RA worth R750,000 which they cash out after emigrating, then the third row of the table applies.

They will be charged tax of R114,300 plus 27% of the amount above R660,000 (i.e. 27% of R90,000)

Tax payable = 114,300 + 0.27 x 90,000
= 114,300 + 24,300
= 138,600

This means they will end up with R750,000 – R138,600 = R611,400

It is important to note that this table applies to RA pay-outs, but also other retirement product payouts (e.g. pension funds and preservation funds). That means you need to combine the values of all the retirement product pay-outs you receive before applying the table above.

It unfortunately also means that you don’t get the first R25,000 tax free per retirement product, but rather across all retirement product pay-outs.

Retirement Annuities And Emigration Going Forward

The future of accessing your retirement annuity after emigration is becoming cloudier.

There have been moves aiming to update the laws around accessing your retirement annuity after you emigrate.

One of the proposals is to only allow access to retirement funds after a person has ceased to be a South African resident and that person has remained non-tax resident for at least three consecutive years or longer. This means there could be a minimum 3 year delay before you will be able to gain access to the fund in your RA, even if you have emigrated.

Should You Invest In A Retirement Annuity?

There are some really great tax benefits that come with using a RA to invest for your retirement.

However, putting your money into a Retirement Annuity means you will be locking it away until you are 55 (although this might be a good thing in terms of forcing discipline if you think you might find yourself dipping your hands into the cookie jar from time to time).

And keep in mind that there are rules around keeping the majority of your investments South African based, and your asset allocation needs to fall within Regulation 28 guidelines. This means that you may not be able to implement the asset allocation best suited to you and your goals inside of an RA.

There is also some uncertainty about the future with regards to Government imposing additional rules about where RA (and other pension fund) money needs to be invested. Prescribed assets is a risk which you should factor in.

And don't forget about the limitations imposed on you when you are over 55 and want to access your RA. Only one third can be taken as cash (subject to tax), and the remaining two thirds must be used to buy a Guaranteed and/or Living Annuity to generate an income for you. This income is subject to income tax. So while there are some tax benefits on RA contributions and growth, there is no Tax protection once you start accessing the money.

Something else that is worth mentioning, is that if you belong to your employer's Pension Fund scheme, then you are already enjoying the same tax benefits on those contributions as you would in a Retirement Annuity. Pension Fund money is subject to the same Regulation 28 rules that apply to Retirement Annuities.

So if you have additional money that you would like to contribute toward your retirement, you can consider upping your Pension Fund contribution (speak to your HR to find out how). Alternatively it might not be a bad idea to diversify away from Regulation 28 funds, while still enjoying some tax benefits, by investing in a TFSA instead of a Retirement Annuity.

In closing, a Retirement Annuity can be a great tool to use when saving for your retirement. But as always there are pros and cons, and your personal situation, risk appetite, goals, time frame and tax situation all play a role in the decision. If you are not sure, then speak to a financial adviser.

Till next time, Stay Stealthy!
- ~ - ~

We're Emigrating

2020-10-09T07:08:00.004+02:00

Trading flags.

When it comes to my finances, I have realized that being efficient is a key skill. Doing the things that gives me the best return per unit of time, money and effort allows me to take the biggest strides forward.

This focus on efficiency is what lead me to move closer to my work, focus on a top down approach to cost cutting, and pretty much why I started forging my own path when it comes to retirement.

And during all of this, I started noticing more and more that one of our biggest expenses is also one of our most inefficient.

Make no mistake, I absolutely love South Africa, and this will forever be my home. We have an amazing country which is still filled with incredible opportunity. But as time has gone on, the awesomeness of South Africa has slowly started getting jaded by an ever growing inefficiency in our expenses.

In fact, this expense is so inefficient, that I end up paying most of it two, three and, now with our second son being born, even four times over. And I have the feeling that this expense is only going to get worse and worse and more inefficient going forward.

Now just to be clear, I absolutely don’t mind paying tax which helps uplift and support those who need it most. I also really don’t mind paying tax for the services which I use.

But man does it irk me every time I see that PAYE line item on my payslip going off and reminding me that I am forking over a large amount of money every month without getting much back in return.

In fact, many of the services my tax money is meant to be paying for, needs to be bought again in my private capacity (in the form of medical aid and school fees – another two of my really large expenses).

Compounding the problem is that inflation on schooling and medical aid often outstrips CPI by a factor of 2 and sometimes even 3. And on top of all of this, is my belief that tax rates are going to be increasing over the next few years.

Our country's budget was pretty much already on the edge before Covid, and now there is an extra burden of a large tax shortfall that needs to be recovered as well as a mountain of extra debt that we will need to repay.

I can’t shake the feeling that we may be heading into a bit of a Tax vicious cycle – more of our small tax base are going to get fed up with high taxes, which in turn will mean more of them will emigrate, which will in turn decrease the amount of tax collected, and that will result in the need to increase tax rates further - circling back to more people getting fed up with the high tax rate.

(Of course that’s just a theory and my own personal viewpoint - South African’s are a resilient bunch and have been known to overcome some pretty immense challenges. Maybe (and I really really hope) I am wrong.)

So this inefficiency (and yes I know, I know crime is bad (although if we going to be complaining about crime we should be complaining about our road death rate too) and corruption, and SOEs and unemployment) has reached a point where I felt it was starting to outweigh the awesomeness of staying in South Africa.

And so I have taken the sad and terrifying, but also immensely exciting decision to accept a job offer in the UK.

In a few weeks’ time my family and I will be packing our bags and emigrating.

Now I am sure there are some questions around this, so let me try address what I think will be some of the more common ones.

Isn’t emigration really expensive?

Yes– Visas, plane tickets, shipping containers, selling up stuff etc etc. adds up very quickly. I am extremely fortunate that the company I am going to are footing most of our relocation bill.

So yes it is going to cost us, but it won’t set as back as much as we initially thought.

Aren’t tax rates in the UK high?

Interestingly the average percentage tax I will be paying in the UK is almost bang in line with the percentage of tax that I am paying in South Africa. But my UK tax expense covers all schooling (with two kids that’s worth north of R1 Million here) and medical (difficult to put a figure on that, but medical aid for our family of 4 (on our cheaper hospital only plan) is around R60,000 year, and that’s excluding all the Doctor’s visits and medicine.

In addition there is also a fairly generous state pension that tax payers are entitled to once they hit retirement age.

So yes, the UK has similar tax rates, but you get a lot back for the money you pay.

But the UK cost of living is crazy?

Housing in the UK is generally very expensive. But note I said generally – because while in places like London you can easily pay upwards of £1200 (~R30,000) per month for a 1 bedroom shoe box, where we are going you can get a 3 bedroom house with a garden for half that cost. That is a little more expensive than in South Africa, but actually pretty comparable.

Then anything service related is pricy – eating out, haircuts, that sort of thing. (And that’s mostly because the minimum wage is so high). But this also varies according to where in the UK you are.

Groceries are maybe a little more expensive, but more or less in line with South Africa.

And of course the higher cost of living is offset by better salaries (at least in the industry I am in). Converting the pound salary I am getting back to rands gives me about a 20% increase in salary.

And then when you consider that minimum wage is around R180/hour, most households do okay even with entry level jobs. So our pretty solid plan B would be for the missus and I to flip burgers if needs be :)

What are you doing with your investments?

For now I have started cashing everything out that is non-tax advantaged. My wife and my discretionary investments are going to be phased out and converted to pounds on the other side.

The UK has what is called ISAs (individual savings accounts). Think of it like a very generous TFSA with a lot of flexibility, a huge annual limit, and no lifetime limit. So these investments will find a welcome home there.

I have left my TFSA, Preservation and Pension funds alone for now, but these will likely get moved over as well sometime in the future. I first want to bed down the physical emigration before the financial emigration.

Are you still aiming for early retirement?

In short yes.

In fact I think I have a better shot of making our early retirement target of 2030 by being in the UK (especially when my wife starts working after our youngest son starts school).

We are definitely taking a step back by moving over (converting our Rand investments to Pounds does not go very far). So our "relative net worth" will be taking a knock over the short term. But I see this as an investment into hopefully getting further ahead over the remaining years.

Having a UK state pension for both my wife and I, and the free schooling and medical is a HUGE plus.

Of course I only have an idea of what our cost of living will be like, and the real planning and journey end date estimation will only happen once we have a better handle on our expenses and plans going forward.

Whether I will make 2030 remains to be seen (and remains an extremely tough ask), but I am certainly going full steam ahead to try make it!

What’s going to happen to the blog?

Well, for now not much.

After more than 4 years of blogging here, there is quite a collection of articles which I believe people will still find useful. You may have noticed some ads have appeared on the website of late (please let me know if you think they are too intrusive or whether you think they are at an acceptable level which does not degrade the reading experience). At this point the ads should cover the hosting and domain name costs of the website, allowing the site to pay for itself.

As I mentioned, I will be leaving some investments behind in South Africa for now, so I may well still post going forward, but it is not going to be as regularly as the last 4+ years.

Some pages will also be “retired” (they will be left at their URLs to ensure no broken links, but they won’t be listed on the home page etc. anymore). Unfortunately no more meetups, and the tracker page won't be updated going forward as I move my money over to the other side.

I am going to try stay responsive to questions I get via the website's contact form, but expect a slower turnaround time as I try simultaneously deal with all the emigration admin.

As for my social accounts (Twitter and Facebook) I will probably keep those going. While a lot of financial principles and my thoughts around personal finance transcend currencies and geographies, there will naturally be some Pound, Fish and Chips (and obviously) kak weather related content appearing on my socials in future :)

I may start a new blog once we are settled in the UK, but that could be a while away as my focus moves fully towards getting set up and settled in our new country. I may even continue to keep this blog going. Who knows! :)

Yes, but isn't the weather really horrible in the UK?

Well would you look at the time, that's enough questions!

Farewell, for now...

This blog has given me an immense amount of pleasure and I have had a lot of fun interacting, sharing and learning with all of you. I have also had some incredible opportunities open up as a result of the blog - including a few radio spots and even a TV appearance :)

I thank every one of you who ever left a comment, shared a post, liked a tweet or gave me a mention - you have helped grow the personal finance and FIRE community by spreading the word.

Over the years I have seen a really vibrant, inspiring and just downright cool community forming around helping South Africans be better with their money. Long may it continue!

Thank you for joining me on my journey up until this point, and I wish every one of you every success in your own journey.

May you all achieve financial freedom!

Till next time,

Stay Stealthy!

Bullet-Proofing The 4% Rule

2020-09-15T05:11:00.001+02:00

Don't let the market shoot holes in
your financial freedom

If you are familiar with the 4% rule, you will know that it's a great guide for retirement planning, as well as for managing your drawdown in retirement.

A quick recap on the 4% Rule if this is the first time you are hearing about it – the 4% Rule is based on some research which found that, historically, the maximum starting drawdown (money you take out) of an investment portfolio should not be more than 4% of the portfolio’s value if you don’t want to run out of money in retirement. You can then increase this amount by inflation and, in theory, you should be good for many decades.

The rule came about because of a dilemma that has (and will continue) to plague us – how do you make sure your money lasts for the whole of your retirement?

The 4% Rule is a great way of answering this question, but it is of course just a guide – there is always the very real possibility that it does not work out (I ran some of the numbers a few years back, and while the rule is pretty solid, it is not a sure thing (nothing ever will be))

Running out of money in retirement could be a ~~f-up of epic proportions~~ big problem, and it is definitely a risk that anyone retiring (early or otherwise) would like to mitigate.

On the other hand, there is another (way more palatable) problem with the 4% rule – it often leaves you dying with way too much money. We would all hate to be left wishing we ordered the lobster in Monte Carlo instead of the burger in Umhlanga.

Nice problem to have though!

Right, so how do you deal with these two problems? How do we balance our drawdown rate so that we don’t run out of money, but are able to spend/give more to ensure we don’t die with a proverbial shit-tonne of money either?

Well, you could mitigate the risk of running out money by using a lower starting drawdown rate (e.g. using 3% instead of 4% will make it far less likely you will run out of money). But then you considerably increase the likelihood of dying with far too much money.

Conversely, you could make sure you get some decent spending out of your portfolio by using a higher drawdown rate (e.g. using 5% means you will be able to spend more.) But then it is far more likely that your investment balance will hit 0 while you still need an income.

So it seems benefiting on one side leaves you light on the other, and vice versa…

I think a slight tweak is required…Let’s throw another rule at the problem.

The 20/10 Rule

When you layer the 20-10 rule on top of the 4% rule, you end up with a nice framework that is able to manage both the problem of running out of money as well as the problem of dying with too much money.

Here’s how it works.

You start your drawdown rate as per usual (e.g. at 4%). Then, just as the 4% rule allows, you adjust the amount you take out of your investment portfolio by inflation with each passing year. Nothing unusual here.

But while you are doing this, you also keep an eye on the investment balance of your portfolio. With each passing year, as the markets do what they do, your balance will rise and fall. And here is where you start applying the 20-10 rule.

Before drawing down on your portfolio each year, check what percentage of the portfolio your planned withdrawal is at.

The 20 part of the 20-10 rule now kicks in.

If the percentage you are planning on taking out differs by more than 20% of your starting drawdown rate, then you adjust the amount you would have taken by – yes you guessed it, the 10 part of the 20-10 rule – 10%.

In other words:

If your next drawdown percentage is >20% higher than your initial drawdown percentage, it means your balance is low, and the chances of you running out of money is now higher. So you have to take a 10% pay cut.
If your next drawdown percentage is >20% lower than your initial drawdown percentage, it means your balance is growing, and your chances of running out of money has decreased. So you can give yourself a lekker 10% pay rise.

Okay, all that is a bit of a mouthful, and it may seem quite complex. So I think it's time for an example to help simplify and explain it.

Let’s say you call it quits with an investment balance of R9 Million. You start your drawdown at 4%, and take out R360k to cover the next year of expenses (that’ll give you R30k a month).

So the first thing to do, is bed down the 20% of the 20-10 rule.

If the starting drawdown is 4%:
20% more than 4% => 5%
20% less than 4% => 3%

So, if the amount you are planning on drawing out ever gets to 5% or more, you will need to take a pay cut of 10%.

And if the amount you were planning on drawing out ever gets to 3% or less, you will give yourself an increase of 10%.

For this example let's assume that inflation is 5%.

So each year you increase the amount you take out by inflation, as the 4% rule allows. In year 2 you take out R378k, and the year after that R396,900 and so on.

That means, in the fifth year, you would be planning to take out R437,580.

Now let’s look at two scenarios.

Scenario 1 – Low Market Returns

Let’s say the market had not performed as expected, and there were a few years of low/negative returns. As a result, your investment balance after 5 years is R8.58 Million.

Since you planned on taking R437,580 from R8.58 Million, it means your planned drawdown is 437,580/R8.58 Million = 5.1%

This means the drawdown percentage has breached the 20% high level, and you need to implement a 10% pay cut. Instead of drawing out R437,580, cut that by 10% and take out R393,822.

Of course this isn’t lekker, but at least you will not be blindly relying on the 4% rule and increasing the risk of running out of money.

Scenario 2 – Good Market Returns

Now let’s say the market had a good run in those 5 years, and your investment balance reaches R14.6 Million (never say never!)

Since you planned on taking R437,580 from R14.6 Million, it means your planned drawdown is 437,580/R14.6 Million = 3%

The drawdown percentage has hit the 20% low level of 3%, and it’s time for a 10% pay rise. Nice! Instead of drawing R437,580, up that by 10% and take out R481,338. Go on an extra holiday, spoil somebody, donate to charity.

This is how the above two scenarios look in picture form (click for a larger image).

In the following year you continue aiming to increase the drawdown amount by inflation, and you again check the percentage you are taking out to see if you have hit the 20% high and low level (5%/3%).

Repeat.

And that's pretty much it!

The 20/10 rule is a great addition to your retirement drawdown tool kit. It helps protect you in environments where returns are low by stopping you from eating too much out of your retirement capital. At the same time it allows you to increase your spending if the circumstances permit.

While the 4% rule is pretty rigid and can fail if the market is not on your side - adding the 20/10 rule on top of it gives you some flexibility, and can be a great way to reduce your retirement drawdown risk.

Till next time, Stay Stealthy!
- ~ - ~

5 Ways To Hack A Home Loan

2020-09-01T05:10:00.002+02:00

Own it, bond free, in 13 years instead
of 20

For those of us who aren't trust fund babies, a home loan is pretty much unavoidable if you want to buy a house.

And yes, due to the duration of a standard home loan, doing it this way means you are going to be paying a lot of interest - a 20 year home loan means you will pay around double the purchase price of the house after you factor in the interest.

A R1 Million Bond over 20 years with an interest rate of prime (7%) will have a monthly installment of R7,753.

Paying the minimum means the bond is paid off in 20 years (240 months) and the total interest bill will be around R860,000.

So how do you reduce the amount of interest you pay the time it takes you to own your house outright?

1. Have A Deposit

A 10% deposit reduces the bond amount to R900k.

That means the monthly installment is now R6,978 (which is around R775/month less). The total interest bill is becomes R775k (which is R86,000 less than the R1 Million bond.)

A deposit is also a great way of showing the bank you are a good financial planner (since you were able to save up towards a deposit.). It also reduces the banks risk. They are now only lending R900k for something that is technically worth R1 Million. This gives them a bit of a cushion if something goes wrong.

All this means that having a deposit not only saves you a lot of interest, but it also will improve your chances of getting a bond approved and can help you negotiate a better interest rate (which, as you will see next, can save you even more interest)

2. Negotiate A Better Interest Rate

When applying for a home loan, apply at all the banks (not just the people you bank with). Use a bond originator as well. Then wait and compare the banks offers, and negotiate using the best offer you received as ammunition. When you are done, go back one more time and ask the bank if that is their best offer.

This seems like a lot of effort, is it worth it?

Well, even a small reduction in the interest rate of your bond can pack a big punch! A 0.25% reduction on a R1 Million bond reduces the installment to R7604/month and saves you R35,800 in interest!

(You can also improve your chances of getting a better rate by checking and improving your credit score)

3. Pay Extra If You Can

The interest on your home loan is calculated daily. That means if you make additional payments into your bond, it immediately starts reducing your interest bill.

Even an extra R200/month:

Saves you about R52k in interest
Means your bond is paid off 1 year faster

(You can click for a larger image)

4. Negotiate The Purchase Price / Buy For Less

Negotiating the purchase price of the property and/or buying a house for a little bit less than what you can afford can save you thousands of rands of interest. A lower home loan amount has a huge impact on the total cost of a home loan - especially if you put the savings into the bond as an extra payment.

A R900k home loan has an installment which is around R775/month less than the installment on a R1 Million home loan. If you put that R775/month saving back into the bond:

Interest saved ~1/4 Million Rand
Bond paid off in ~16 years

5. The Biggest Hack - Do All Of The Above

What if you managed to:
- Buy for R900k (instead of R1 Million)
- Put down a 10% deposit (a R90k deposit means a home loan of R810k)
- Got your interest rate down to 6.75%
- Put all savings back into your bond and
- Paid an extra R200/month?

Congratulations!

You have just saved yourself R460k in interest and paid off your home loan in 13 years instead of 20!

You're Not Done Saving

And when you done implementing these hacks, and you thought that was it...

Some of the banks allow you to renegotiate your home loan's interest rate once the loan has been running for a while. If you have been a good payer, and especially if you are ahead of your payments, you can probably get your bank to squeeze out some more interest rate savings for you - but you have to ask (they won't just do it out of the goodness of their hearts!)

I managed to get the bank to lower my interest rate by simply dropping them a mail and asking.

Just be aware that only some banks will renegotiate your rate, some will refuse point blank *cough* Standard Bank *cough cough*. (That's also maybe something to consider before signing up for a home loan)

And finally - if you want to stay on top of your home loan and check out the dent you are making with extra payments, download this home loan tracking spreadsheet and watch how your home loan freedom date gets pulled closer and closer.

Till next time, Stay Stealthy!
- ~ - ~

The Self-Insurance Snowball

2020-08-19T06:07:00.000+02:00

Just when you thought Winter was
nearly over.

Insurance is good business - it’s why the actuaries get paid so well! When Maths is on your side, you know you gonna win.

The average insurance premiums are designed so that, on average, for the average person, the insurance company wins. (Wow that’s a lot of averages in one sentence – see I told you Maths was against you).

The way insurance works is that the premiums of the many subsidize the losses of the few, plus some decent profit for the insurance company. So when it comes to insurance, chances are you are going to lose.

And for those that do start winning? Well, their premiums are adjusted upward accordingly.

So it makes sense that over the long term, the average person will be better off with as few insurance products as possible. Yes?

But please, don’t run off and cancel all your policies!

The problem is that insurance is pretty also really important – the risk of some events derailing your entire life are very real and need to be insured.

So wouldn’t it be awesome if you could have the benefit of insurance without needing to pay an insurance company? Luckily there is a way to do this – it’s called self-insurance.

What Is Self-Insurance?

Self-insurance is when you have money set aside to cover you for an event you would normally take out insurance for. If the event you are self-insuring for happens, then you cover the cost from your own pocket instead of claiming from an insurance company.

A lot you may already be self-insuring without even realising it. As an example, your excess on your car insurance is actually a form of self-insurance since you will need to cover the excess in the event of a claim.

And of course an emergency fund also serves as a sort of all-purpose self-insurance tool that, depending on the size, could cover anything from a new car battery to your salary for a few months if you lose your job.

Self-insurance means you weighing up the certainty of spending money on insurance premiums versus the possibility of incurring a loss that you will pay for yourself. The benefit is that money which was previously going to an insurance company in the form of premiums stays with you, and over the long run, on average you will score. The more things you are able to self-insure, the better off you’ll likely be.

So how do you go about self-insuring?

Well, let me introduce you to what I like to call the Self-Insurance Snowball Method (patent pending).

The Self-Insurance Snowball Method

The snowball method for self-insurance is pretty similar to the snowball method for debt elimination. In the debt snowball method, you pick your smallest debt and then use an additional payment to squash that. After that, you take that debt’s installment value and roll it into the next biggest debt until that one is eliminated. Then you take the previous two debt installments and roll it into the next biggest debt and so on and so on, creating a snowball effect that gets bigger and bigger until you are debt free.

The snowball method for self-insurance works in the same way. First you pick your lowest value insured item/event (this will likely be the lowest of all your premiums). Put away a monthly savings amount until the item/event is self-insured. Then roll that insurance premium into the savings pool until you have enough to self-insure your next highest valued item/event. Then roll that premium into your savings pool etc. etc.

It's pretty simple in theory, but understand that it is not going to happen overnight, and it will require some patience and discipline. It is also important to know that this method assumes that you have an emergency fund set up – if you don’t, you should probably do that first.

Okay, so here is an example of how the self-insurance snowball might play out in practice.

Maybe your lowest valued insured item is your Cellphone. Let’s say it is worth R3,000, and the premium is R150 a month.

Now assume the worst. Your phone gets stolen or you drop it in the toilet, and you find yourself in the...er…shit.

Well, to be honest, if your emergency fund is up and running, this is actually no problem and you could just foot the bill of a new phone out of your emergency fund. Alternatively you might have a spare phone lying around that you wouldn’t mind using.

But if these two options don't work, then you would need to carry on building your savings until it is at a value that could handle replacing your phone.

Either way, your cellphone is now self-insured. You can go ahead and cancel your Cellphone insurance. And voila, you have the first part of your self-insurance snowball ready to…er…roll!

So next up, make sure you start saving the R150 premium you were previously paying for your Cellphone insurance (it is probably best to do this immediately and automatically - to make sure that the R150 goes to where it is supposed to).

Now find your new lowest value insured item – maybe it is funeral cover, or a laptop. Let’s say the insured value is for R8000 with a premium of R250/month. Wait until the R150/month saving from your previous Cellphone insurance boosts your savings to a point where you are comfortable that it could cover you. You are then ready to self-insure, and you can now use the R150/month + your new R250/month you have freed up to snowball towards saving for self-insuring the next item.

(I must maybe just mention that for something like funeral cover, you should probably put the self-insurance savings into an account that can be accessed by your family if they need it.)

You can keep snowballing like this and knock off insurance premiums one by one. Maybe the next item is your car. Now this one can be a biggie, and it could take a very long time. A slightly different approach could be to self-insure a higher and higher excess over time. For example maybe aim to save up an amount that would cover a R5,000 excess. Then call up the insurance company and tell them you want to increase your excess. This will lower your premium. Then roll those savings into your snowball and aim for a R10k excess. Rinse and repeat until the car is self-insured.

And that’s the basic idea – roll any self-insurance savings into self-insuring the next item/event. Just keep rollin, rollin, rollin...

How To Self Insure

1) Make sure you have an emergency fund. If you don't, build one up.
2) Find your lowest value insured item/event. Self-insure it by either:

Checking if your emergency fund/savings can cover it
Building up enough savings to cover it
Using an alternative way (e.g. if you have a spare, getting by without, other out the box ideas)

3) Start saving the self-insured item/event’s insurance premium.

4) Revisit step 2 until there are no more items/events you can self-insure.

There are maybe just two more things I want to mention…

The first is that the above scenario assumes smooth sailing with no claims. If along the way you need to make a “self-insurance claim” it may knock your savings, and you may need to re-instate some insurance at a company to cover you until your savings have been built up again.

The second important thing to know is that, unless you are exceptionally wealthy, it’s probably not a good idea to self-insure everything. Some things are best left to insurance companies.

What Not To Self-Insure

Insurance is designed to cover you for events that you would not be able to cover on your own. Now when the cost of the event is known, it is pretty easy to figure out if you are in a position to make it right on your own.

That means that if the amount needed to self-insure is more than what you could save (even in a lifetime), or if the amount needed to self-insure is unknown, then it is probably best to pay the premiums and not try to be be too clever.

For that reason, I am definitely going to be keeping these insurances:

House insurance – Even if I start now and save until the day I die, I will probably never be able to build up enough cash to replace a house.
3rd Party Car insurance – Self-insuring a car is possible because you know the replacement value. But I definitely would not be trying to self-insure for 3rd party claims. Imagine back ending a Ferrari and being deemed responsible?
Hospital cover – I already self-insure my medical day to day expenses, but I have no plans of trying to self-insure my hospital cover. A hospital visit is one of those bills that really has no upper limit. Imagine being admitted after back-ending the Ferrari from above and spending 3 months in ICU after multiple organ transplants and 42 MRI scans.

The Ultimate Self-Insurance

Now just before we are all insuranc-ed out, I just want to quickly discuss one last type of insurance – life insurance.

Life insurance is there to cover the bills when you are gone. To me that makes self-insuring your life the ultimate self-insurance achievement. If you have enough funds built up that you are able to cover your bills even if you are not there to earn a salary, it means you have achieved financial freedom.

Personally, this is one insurance I am really looking forward to cancelling!

Till next time, Stay Stealthy!
- ~ - ~

Demystifying Credit Scores - An Easy To Understand Guide

2020-08-06T05:40:00.008+02:00

Time to check the scoreboard

Your credit score is a pretty important number.

Why?

Well a good credit score not only influences whether or not you will get any finance you are looking to take, but it also plays a big role in determining the interest rate you get for that finance.

And this is important because even a small decrease in an interest rate can pack a big punch - especially when it comes to buying a house or a car on finance. You can end up saving a lot of money! And even for smaller debt, a lower interest rate will leave you a lot better off.

Fortunately it's pretty easy to understand how credit scores work, and it's also pretty easy to view and track your score for free.

So let's get into it!

What Is A Credit Score?

Your credit score is a 3 digit number representing how well you have handled your debt and payment obligations in the past.

It's pretty simple:

If you have been a payment pro, then you'll have a high score.
If you've been a little naughty with debt (oops), then you are going to have a lower score.

Your credit score is calculated by a credit bureau (an independent company which is licensed to collect credit information of individuals)

There are 4 different credit bureaus in South Africa:

Experian
TransUnion
Compuscan
XDS

The guys with the calculators

The 4 Credit Bureaus collect information about your credit and payment behavior (from lenders, utility companies and even mobile phone providers and insurers.) They use the information in a top secret (for real) formula to calculate your three digit credit score.

And just like that, you become a number :)

Now, because there are four different credit bureaus in South Africa, and they each use a slightly different method to calculate you score, it means that everyone will have four different credit scores. (Okay so maybe you are not just a number - you are four numbers!)

Each credit bureau also has a different maximum value that your credit score can be. For example, at Experian, your total score is out of 705. The other credit bureaus will use a different total.

The credit bureaus also normally include ranges of scores to categorise you, and you might find you fall into a category like "good", "fair" or "bad"

Where Can You Check Your Credit Score For Free?

Okay, so where can you find this magical 3-digit number?

And naturally, if we can see it without paying for it, that's even better!

Well, by law, you are entitled to one free credit report (which will contain your credit score) from each of the credit bureaus. So one option is to go direct to each of the bureaus and ask for your free report.

But there's an easier way to get your credit score online, for free.

ClearScore* is a website that will give you your full credit report from Experian, and you can check it as often as you like (at no cost).

* I have no affiliation.

Getting set up is super easy:

1. Click Log In

2. Click Create new account

3. Go through the steps to register.

4. Once you are registered you will find yourself on their mailing list. You can just ignore or unsubscribe from any of the follow up emails with offers/promos for more credit etc.

And that's it! You are now ready to check your credit score for free.

Once you log in to your account you can immediately see your credit score displayed. Here is what it looks like (using yours truly as an example :))

Notice that the score is out of 705. That is because Clear Score pulls your data from Experian, and Experian calculates your credit score as a value out of 705. Remember, the maximum score at the other bureaus will be different.

You can then also click on "Report" to check your full credit report for free.

Your credit report contains your credit score (which is what we have been talking about till now), but it also includes:

How much credit you have used
Your payment history (and if you’ve missed any payments)
Recent credit applications
Any defaults and court orders against your name
Details of your accounts

As an example, here is my credit report:

So it turns out that I have (mostly) been a good boy – although, as you can see, I lost some points on the multiple credit inquiries I logged last year while doing some research. That pulls my score down a little.

And that brings me to the next important section...

What Affects Your Credit Score?

There are multiple factors which are used to calculate your credit score, but the ones below have the biggest negative impact:

Late/missed payments
Defaults on debt
Court Judgments
Bankruptcy

Any oopsies on the above will stay on your report for 5 years, and have been known to scare lenders away.

The above 4 factors are the really big ones, but if you want a good credit score, you should probably consider the following factors as well.

Factor Affecting Your Score	Top Tip
Applying for credit Every time you apply for credit, a mark is made on your file	Don't apply for too much credit too quickly
How much of your credit limit you're using People who are up to their eyeballs in debt are at a higher risk of defaulting	Keep your debt repayments to less than 30% of your income
Age of accounts Older accounts help your score and look better in the eyes of a lender - age is beauty	Have a good track record of paying your accounts
Frequent change of address If you move around you are perceived to be slippery and difficult to find	Try not to move houses too often

Why Is Your Credit Score Important?

Before the lenders/banks extend a loan, they want to know how risky it's going to be. Someone saying "I promise I will pay you back" is quite simply not going to cut it.

You might know that you are good for the loan, but how does the bank know? Well one of the big factors they use is the value of your credit score.

To the lenders it's simple:

High credit score = low risk
Low credit score = high risk

The way they see it, a high credit score means you have a history of handling debt well. This means you're a "good payer" and so you'll be more likely to get accepted for credit, and also more likely to get a better interest rate on your loan than someone with a low score.

How Do You Improve Your Credit Score?

Improving your credit score is about being responsible with credit:

Don't overextend yourself
Pay all your installments on time, every time
Don't apply for credit multiple times in a short space of time

If you get the above three things right, your score will improve.

Just remember it is not going to happen overnight, but with each passing month the bureaus will recalculate your score and factor in your good payment behavior.

If however you are already struggling to meet your current debt obligations, there are a few things to keep in mind so that you don't totally obliterate you credit score:

A late payment is better than being in default.
Be proactive and get in touch with your lenders to try make a plan before your credit record gets really trashed
Get professional help if you need to

What Is A Good Credit Score Out Of 705 In South Africa?

As I mentioned, your credit score at Experian that you can access for free using ClearScore, is out of 705.

In South Africa, a credit score of between 650 and 669 out of 705 is considered to be "Good". Get into that band and you will get some brownie points from the lenders.

Below are the bands that Experian categorises your credit score into:

Credit score	Experian band
0-527	Very poor
528-602	Poor
603-649	Fair
650-669	Good
670-705	Excellent

If your score is below 528, it is considered "very poor". Anything above 650 is considered "good" and will likely count in your favour when applying for a loan.

But very important to keep in mind is that there isn't a golden number or rule that will guarantee you getting credit. Credit scores are only one factor that lenders consider, and a good credit score might still not be enough to secure you a loan.

Your credit score shows your credit-worthiness, but banks and lenders will also consider other factors like your income, employment and debt levels before deciding to grant you a loan. This is also why the same credit score can get you accepted at one lender but rejected by another.

Do You Need Debt To Get A Good Credit Score?

There's a common perception and gripe that I have seen coming up over and over again, and that is that you need debt to get a good credit score. That of course makes for one of those chicken and egg situations like when you need experience to get a job that will give you the experience you need to get the job...

The thinking is that without debt you can't get a good credit score, but without a good credit score you won't be able to get debt. If you are looking to buy a car or a house soon, this might be playing on your mind.

So do you need debt to get a credit score?

Well, as I mentioned previously, we don't know the secret formula the bureaus use, so we can't be 100% sure if previous debt is an absolute requirement. But from what I have seen, having a good debt repayment record is definitely helpful.

I did find something else very interesting on my credit report though. I noticed that both my cellphone and insurance accounts are listed.

It seems that having those types of accounts may also get you onto the credit score radar. How much it will shift the needle by, I do not know - but I would love to try find out. So if there is anyone out there who has only insurance and contract type products (like a cellphone contract) and has no debt history, if you don't mind sharing, please let us know if you have a credit score and what it looks like?

Till next time, Stay Stealthy!
- ~ - ~

Could The Tax Penalty For Exceeding Your TFSA Limits Be Worth It?

2020-07-28T07:05:00.000+02:00

Is it possible to score from a TFSA
penalty?

Those of you with TFSA accounts should be familiar with the annual and lifetime limits which apply. As it stands, there are severe penalties for contributing more than R36,000 to your TFSA in a single tax year, and more than R500,000 over your lifetime.

In other words, you are allowed to exceed the limits, but SARS will bring out their big, 40% stick.

That means any money you contribute to a TFSA which exceeds the annual or lifetime limits, will be liable for 40% tax. i.e. if you contribute R40k in a year, you will pay 40% of R4,000 = R1,600 in tax.

If you contribute R600,000, it's R100,000 over the lifetime limit, so you will pay 40% of R100,000 = R40,000 in tax.

I think you get the idea.

On the other hand, there are some really great tax benefits inside of a TFSA. SARS won’t charge you any dividends withholding tax, income tax, or capital gains tax on any money inside of a TFSA. And when you view this great perk of a TFSA in light of the over-contribution penalty, it makes for an interesting dilemma...

Is it worth it to take the upfront tax hit to score on the tax benefits inside the TFSA?

Of course, practically, you may not be able to exceed your annual limit (some TFSA providers stop you from contributing more than the annual limit to protect investors from accidentally over-contributing), but let’s assume you found a TFSA provider that would allow you to it.

Let’s also assume someone had not made any TFSA contributions and they just so happened to have the TFSA lifetime limit of R500,000 lying around waiting to be invested.

Would the tax penalty from contributing the entire R500k in a single year, be offset by the tax benefit of having the money inside a TFSA?

It’s an interesting question, and it may also solve for the complaints that many older investors have around not being able to maximise the lifetime limit of their TFSA because they have less than 14 years of employment left (at R36,000 a year, it will take you around 14 years to hit the current lifetime limit).

Okay let's check this out by running 2 scenarios. Someone with R500,000 to invest could either:

Dump it all into a TFSA, take the tax hit, and let it run inside the TFSA without making any further contributions. Or,
Phase the money into a TFSA at R36,000/year until the lifetime limit is reached.

Let’s assume that in both cases, this person’s TFSA is invested in a diversified, equity heavy portfolio which generates 12% per annum.

If this person dumps the entire R500k in, it means they will exceed the R36,000 limit for that year by R464,000. This means they will be taxed at 40% of R464,000 = R185,600 (ouch!). Let’s also assume that they pay this tax hit upfront.

All this means that a total of R314,400 lands in the TFSA account. Let's check how that plays out versus a R36,000 per year contribution over 14 years (click for a larger image).

At the end of 14 years, the investment balance of dropping the R500k in and paying the tax penalty is R1,536,508.

This compares to phasing the money in R36k at a time, which leaves you with an investment balance of R1,301,589.

So throwing it all in and taking the tax hit leaves you around R235k better off – seems like a great idea right?

Not yet - there are still 2 more factors to consider...

Firstly, it might be possible to pay the tax hit from outside of your TFSA account – i.e. you can make sure that the full R500k hits your TFSA account (and not just R314,400). In order to do that you would need R500k plus an extra R185,600 to cover the tax bill – a total of R685,600.

And then there’s something else we overlooked in the previous scenario...

If you did have the lumpsum available to phase into a TFSA, you would add the R36k a year, but it’s unlikely that the rest of the money would just be sitting idle. No, it would probably already be invested somewhere else earning a return while it waited to be transferred into a TFSA. Not so?

So let’s assume the remaining money is invested in a similar asset allocation as the TFSA. Again we assume a 12% return, except, this time it is subject to all those delightful taxes you need to pay outside of a TFSA - Dividends Withholding Tax, Income Tax etc.

Dividends Withholding Tax is a flat 20%, and let’s assume the portfolio’s returns include 2% from dividends. 20% of 2% means that the returns loose 0.4% per annum to dividend tax. Income tax is a little more tricky to account for since that will depend on your marginal rate and how much of your portfolio is in REITs. So let’s estimate it adds another 0.4% drag on returns. This leaves a total of 0.8% per annum lost to tax - i.e. the non-TFSA money earns 11.2% per annum.

So now the two scenarios are:

Take a lumpsum and invest R500k into a TFSA at once, pay the tax hit of R185,600 for a total investment cost of R685,600. Or,
Phase a lumpsum of R685,600 into a TFSA 36k at a time, while the rest stays invested in a discretionary account earning 11.5% per annum.

Here's what it looks like over 14 years (click for a largerimage).

Leaving the rest of the money invested now makes the tax penalty option pretty painful! Phasing the money in leaves you with R3,109,685 versus the R2,443,556 you get after dropping it all in and paying the tax penalty. That's leaves you around R666k (ominous!) better off by phasing it in.

Okay, so that covers the scenario up to 14 years, at which point the TFSA has been maxed. But what about running it for longer, does the benefit of being in a TFSA kick in then?

Well I extended the scenario to 100 years, and still, taking the tax penalty leaves you worse off. You just cannot recover from that 40% hit!

And then finally, there is still maybe one more benefit of a TFSA which I have not considered - the fact that there is zero CGT payable in a TFSA when you sell.

Now it is highly unlikely that someone will just up and sell their entire TFSA at once (it's far more likely that they'll sell off portions annually once they hit retirement) . But let's assume they want to sell it all. Let's also assume that they pay the highest CGT rate - 18%.

How does the tax hit versus phasing it in numbers look now?

After 14 years:

Lumpsum with tax hit - R2,443,556 (i.e. still the same, no CGT payable in a TFSA)

Phasing it in, CGT payable on discretionary investment - R2,784,228

So it's still better to phase it in.

And what about longer time frames?

Well, after 26 years or more, if you consider the CGT implication of selling the entire investment, you will be better off by taking the tax hit instead of phasing it in.

So does that make it worth incurring the tax penalty?

In my view - no!

(Unless you plan on investing it for over 26 years and you going to sell the entire investment and you will be bringing in more than R1,577,300 per annum in retirement (making you a 18% CGT kind of earner.))

Till next time, Stay Stealthy!
- ~ - ~

How To Calculate Real Returns (For Real)

2020-07-14T06:14:00.000+02:00

Real returns - better than fake ones.

We need to get real. Realistically speaking, as much as we would really like to keep all of the return our investments generate, the reality is inflation secretly steals some of that return.

Okay that was really bad! Doh! Oops, I did it again!

Right, let’s try that again…

Knowing your real return is important, because it represents how much better off you are after you factor in the eroding effects of inflation.

Remember that a return of 20% might sound phenomenal, but if inflation is also 20% it means you haven't made any progress (and if your return was less than 20% then you are actually getting poorer).

How To Calculate Real Returns

Let’s start with an example. If you managed to get a return of 9%, and inflation is 5%, what would your real return be?

A commonly used method for calculating real return, is to take the return you get and simply subtract inflation.

Real return = Return – Inflation

So in our example:

Real Return = 9% - 5%
Real Return = 4%

This intuitively makes sense – you want the return after inflation, so just take away the inflation part.

Now this is not a bad start, and there are many people who (possibly dangerously) use this as the actual real return. But this method is actually not 100% correct and should only be used as an estimation.

Okay so how then do you calculate the actual real return?

Let’s continue using our 9% return, 5% inflation example…

Let's say you had R100 (you baller you!). And let's say that, coincidentally, a widget also costs exactly R100.

Using some advanced Maths, you can work out that your money can buy you precisely 1 widget.

Now, let's say instead of buying a widget with your R100, you invested it and got a 9% return. After 1 year, you will have R109.

In that same year, inflation (at 5%) results in the price of the widget increasing to R105.

So that means you can now buy R109/R105 = 1.038 widgets.

In other words, in widget terms (what your money can actually buy), you are 0.038 widgets (or 3.8%) better off than you were in the previous year. And this measure of how much better off you are is, yes you guessed it, your real return.

So in this example, your real return is 3.8% (and not quite as good as the 4% previously calculated).

Let’s get into some Maths and formalise the above example. The correct way to calculate real return is as follows:

Okay, so that’s cool and all, but what is the big deal? Can’t we just use the estimated real return (which is a lot simpler to calculate)? Does the difference really matter?

Well, in lower inflation, lower return environments like the US and Europe, it actually doesn't matter that much.

For example, with returns of 5% and inflation of 1% (plug it into the formula above if you want to practice):

Estimated real return = 4%
Actual real return = 3.96%

That’s no biggie.

But in high inflation, high return environments (like the good old RS of A), the difference is bigger and can affect planning and projections (especially over the longer term).

For example, with returns of 12%, and inflation at 8%

Estimated Real Return = 4%
Actual Real Return = 3.7%

That 0.3% difference doesn’t seem like much (and over one year it isn’t), but over time it starts creating a significant gap between the estimated and the actual investment balance. This can really mess with any long term planning and projections you might be running.

What’s Your Inflation Rate?

In the above examples it was pretty quick and easy to claim inflation is 5% and happily Math away. But in reality, what is the inflation value you should use? This is an important question, because inflation will directly impact your real return - the higher inflation is, the worse your real return is going to be.

Of course you could use the nice broad average annual inflation rate of the country which is published by Stats SA. Although this value is useful, it can also be a little dangerous – because it is unlikely that it represents inflation as you experience it.

So, for that reason, something I like to keep an eye on is my own personal inflation rate. I then use that value when calculating real returns.

If you are interested in calculating your own personal inflation rate, check out this article and free spreadsheet download which can do the number crunching for you.

Till next time, Stay Stealthy!
- ~ - ~