Most people, when starting to save for the first time, simply deposit their money with their bank, either in a notice or fixed-term deposit. While this feels safe, there are still risks.
The first risk is the bank being put under curatorship – as happened to African Bank in 2014. Having all your eggs in one basket could lead to financial ruin in a scenario like this when assets are frozen and most, if not all, interest is lost.
Second, putting the worst-case scenario of a bank failure aside, large bank deposits also carry the risk of money not keeping up with inflation after tax, as interest earned is taxable along with personal income. This is particularly true if your client has grown a large deposit and their annual income puts them in the 41% or 45% tax bracket.
To beat inflation, you may help your client diversify their portfolio by growing their wealth over the long term in non-bank investments, such as unit trusts.
Your client will likely have questions about this option – so read on for a few guidelines on how to answer them.
How much interest is offered?
Coming from a background where initial savings are usually with a bank, it’s understandable that the most common question asked by investors looking to take the leap to unit trusts is, ‘How much interest do you offer?’
Unlike bank deposits, though, unit trust funds don’t offer a guaranteed interest rate. Instead they invest in underlying assets, the prices of which go up and down. They take on this risk – called market risk – in an effort to deliver higher returns for investors than that of a bank deposit over the long term.
The extent to which prices will go up and down is unknown at the start of the investment, so it’s impossible to say beforehand how much your investment will return.
Could I have the maximum return, with no risk, please?
Investor nirvana would be a place where you get the highest possible return with no risk. Unfortunately, investor nirvana doesn’t exist. For starters, no form of saving or investment is entirely risk-free.
There’s a direct relationship between the size of potential returns and the size of market risk you need to take on to achieve those returns. To achieve above-average returns, you need to be willing to face the risk of your investment value going up and down at times.
I don’t like risk. Is it really worth it?
It could be, if your client can commit to staying invested despite the emotional roller-coaster ride of having their returns wiped out by a market crash over the short term, as we saw in 2018 when the local stock market dropped 8,5% and listed property delivered a shocking –25,3% in one year. Because over 10 years or more, the more volatile high-risk unit trusts generally deliver a significantly higher return than cash.
In the example on this infographic we compared investing in cash at 7% per year versus investing in high-growth assets giving potentially as much as 11,5% year on average. An amount of R100 000 invested at 7% at the start of 10 years comes to just under R200 000 at the end of the 10-year period; that same R100 000 can potentially grow to nearly R300 000 in high-growth assets.
Over 10 years or more, whether your client chooses a bank deposit or a high-risk unit trust can mean the difference between doubling or tripling their money! But taking on more market risk is not for everyone.
Some investors can’t afford to take on much market risk, such as retirees or anyone else who’s relying solely on their investment for a monthly income. It’s hard for someone to absorb the shock of a market crash if they need to pay their bills from the income linked to their (suddenly diminished) investment value.
And this is where your expertise as an intermediary comes in – to help clients understand how much risk is appropriate for them. Prepare for your leap into the unknown.
If you’re ready to take the leap and take on more risk – defined as uncertainty in returns – it’s a good idea to do more research before you invest, and also to put a safety net in place.
Read the full client version and an interesting infographic here.