How should I invest R500k for my newborn son’s education?

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Dear Reader,

Thanks a lot for writing to us.

If your risk appetite allows you to take risks, I would definitely say you should consider long-term, high equity funds. Sanlam has a risk profile questionnaire that you can use to assess your risk appetite.

You have the capacity to take risks as the investment will be held for a period longer than 10 years. Risk capacity is the maximum amount of risk that an individual is able to take on, and risk appetite is the amount of risk that an individual is willing to take on.

You will have to be able to stomach the short-term volatility and stay invested through the tough times. The investment will fluctuate. The investment will go down in value. The investment will have periods where it struggles to outperform even a money-market fund.

The most important thing to remember when investing in a long-term fund is to stay invested, never make emotional decisions, never sell when the fund is down, and to stick to your game plan.

Below I will show you a comparison between short-term, medium-term, and long-term funds. This will give you a bit of an idea of ​​what to expect when investing in a long-term fund (volatility not returns). Short-term funds aim to provide capital protection and some growth to keep up with inflation, medium-term funds aim to provide CPI+5% and long-term funds aim to provide CPI+6% even though their benchmarks are usually connected to a peer average or index.

I have compared four different funds from the same fund manager below. The red line is a money market fund. The gray line is a balanced fund. The black line is a local equity fund and the teal line is an offshore equity fund. You will see that the more aggressive funds had a good three-year period, but not so much over a five-year period. The true test comes over the 10-year period and as you can see the offshore equity fund outperformed the other three funds. The local equity and balanced funds had similar growth while the money market came in fourth. The only reason I am showing you this is to illustrate the fact that long-term funds cannot be invested in short-term funds.

One-year returns

Three-year returns

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Five-year returns

Picture3 1

10-year returns

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Where to invest?

Unit trust vs ETF/index fund

Unit trusts are actively managed, whereas ETFs (exchange-traded funds) are passively managed.

An index tracker will track an index like the S&P 500, FTSE 100, World Equity, emerging markets and so on.

Each ETF fund can only track one index. A unit trust fund manager can invest in a range of assets within one fund, such as equities, cash, bonds, property and offshore. Both of these investments offer a great way to access the market and start investing, and having a combination of both can be advantageous.

I like using ETFs for long-term investing as the costs are kept to a minimum and the overall diversification between various companies you receive.

Tip

Use different ETFs/unit trusts to diversify your portfolio. Have a look at various geographic, currency and sector funds. Keep it simple and don’t use too many funds. Don’t use funds that correlate with each other. The fund fact sheets will show the various companies invested in and you will be able to see if there’s an overlap.

In whose name to invest?

If the money is in your name and you transfer it into your son’s name it would be deemed as a donation. According to Sars, the person making the donation (donor) is liable to pay the donations tax at 20%, however, if the donor fails to pay the tax within the payment period the donor and donee are jointly and severally liable (Section 59 of the Income Tax Act).

What you can do is invest the money in your name, and use your R100 000 per annum donation allowance to transfer it to your son’s investment each year. There are some other tax considerations, such as interest and capital gains tax, so talk to a financial advisor or your accountant regarding these taxes.

Feel free to contact me if you would like more information.

Happy investing!

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