Aligning your savings time horizon with the best investment options
The longer you can avoid dipping into your savings, the greater your range of investment choice is. When markets are volatile – as they have been in recent years – it is even more vital to be realistic about your time horizon to get the most from your investments.
Knowing how the time horizon of different types of investments affects savings outcomes can help investors choose the most appropriate investment vehicle to earn the best possible growth over time.
The savings levels of working South Africans are low at just 15% of their income. But according to research on the South African market, savings for the entire population are even lower at just 3%, reflecting the overall low savings rate of South Africa, according to the Old Mutual Savings Survey.
Investors often choose bank fixed deposit accounts and money market funds as both benefit from set interest rates and provide fairly easy access to savings. Average 12-month interest rates for fixed deposit accounts from South Africa’s four biggest banks are currently around 5.5% to 7.5%. Average money market rates are around 7% to 8%. With money market funds, investors can get access to their money within 24 hours, which is a significant benefit.
By choosing to “move up the yield curve” which means investing in fixed income funds, investors can get average returns of between 7% to 9%, immediately adding almost 2.5% extra in returns while keeping within low-risk investment. Although these funds should be retained for at least 12 months, investors still have access to their funds within 48 hours, which is a major benefit.
Unit trusts and tax-free savings accounts
Unit trust tax-free savings accounts are also within the low-risk investment category and can be used to save for a few months or even several decades. They provide access to underlying funds and are a good way to combine tax efficiency with investment savings.
Investors can save R33 000 a year up to a lifetime limit of R500 000. Growth on investments is tax free and so is the money that investors withdraw from the account. Used as a pre- and post-retirement savings option, tax-free savings accounts can have a lifespan of 40 years.
Equity-based investments, such as property, equity and balanced funds are found further up the time horizon spectrum. These require a time horizon of more than five years as the opportunity they provide to earn higher returns also entails taking on more risk.
Over the long term, equities have proven to be the highest-performing asset class but it can take years to recover from short-term downturns. Investors saving for less than five years may not have time to recover from a market correction.
Equity returns vs bonds and property over 23 years
Balanced or Multi-Asset unit trust funds
Balanced or multi-asset funds have an investment time horizon similar to equity funds, typically around seven to 10 years, as managers focus on longer term macroeconomics and business cycles to position portfolios for growth, while keeping volatility low.
Balanced funds aim to provide investors with “the best of both worlds” by including exposure to equities and bonds. The equity allocation can range from 60% to 75%.
Understanding investment time horizons is not just about ensuring investors’ portfolios have time to recover if there is a market downturn, it is about understanding what influences managers’ decisions.
Investing in a balanced or equity fund positioned for a business cycle five to seven years ahead, when your personal time horizon is less than five years, means your outlook is not aligned to how the manager is managing the fund.
Investors can go wrong by choosing an equity or balanced fund and then stressing about short-term underperformance when the manager is managing the portfolio for the long term.
Investment time horizon of different types of investments
At the extreme end of the spectrum are private equity and other alternative investments such as infrastructure and credit funds, typically only available to high-net-worth investors with a minimum lump sum investment of R1 million. If you fall into that category, these types of investment are suitable for a goal such as putting money away when a child is born for his or her future education in 20 years’ time.
Over the 10 years to December 2017, private equity funds managing assets of between R500 million and R1 billion returned 18.4% a year, according to the latest RisCura SAVCA South African Private Equity Performance Report. South African equities returned 10.7% over the same period.
It is important not to over- or under-estimate your time horizon. If you and your financial adviser are not planning to access your savings for 10 years, consider investments with a higher risk return profile that can enhance your returns.