How to navigate tax-free savings accounts
For the past three years, the answer to the question, “how do I start investing?” has been easy: open a tax-free savings account (TFSA).
But this comes with the caveat that there are broadly four types of TFSA — and most people, misled by banks and insurance companies, open the wrong ones. This is disastrous because the existing regulations do not make it easy to switch accounts.
A handy resource to start researching TFSAs is www.savetaxfree.co.za, created by Stuart Theobald, of Intellidex. The financial services research house also conducts an annual survey. It’s hoped the 2017 poll of TFSAs will show people have woken up and are not simply going to their banks to sign up for the completely pointless money market accounts on offer.
The 2016 survey showed 59% of the R2.6bn savings TFSAs attracted went to banks. This is sad if you consider that, under existing laws, the first R23,800 interest you earn if you are under 65 is tax free. This rises to R34,500 if you are older.
Assuming a bank’s interest payment to savers matches the central bank’s 7% repo rate (in reality, they aren’t that generous), it would require savings of R340,000 before the existing tax-free threshold was breached. As the highest amount of savings that could have been placed in a TFSA in its three-year existence is R93,000 — the annual limit was raised to R33,000 this tax year from R30,000 in the prior two years — people who have opened TFSAs with banks are not getting any tax advantage they would not have enjoyed in any case.
Insurance product floggers have led people to believe bank TFSAs are the only type available. They use the argument above to convince people to rather put whatever they can afford into retirement annuities. People who fall for this are basically volunteering for double taxation: if you are a wage slave already contributing to a company pension fund, money you put into a retirement annuity comes from your after-tax salary. And when you draw it later as your pension, it gets taxed again as income.
Intellidex’s survey found the life insurance industry has managed to grab the next biggest slice of the TFSA pie (15%). This leaves stockbrokers and unit trust traders (commonly called Lisps — an acronym for linked investment service providers) tied in third place, with 13% each.
My bias is towards the TFSAs offered by stockbrokers. The fees are far lower than those for full-featured stockbroking accounts, but TFSA stockbroking accounts are limited to a selection of exchange traded funds (ETFs).
Using my Absa Stockbroking TFSA as a reference, the choice of ETFs that can be traded via the account is 39. Stockbroker TFSAs exclude eight ETFs from the JSE’s full menu. The excluded ETFs are those focused on single com-
A big advantage TFSAs have over pension products is that they are not constrained by rules limiting foreign shares
modities rather than offering diverse portfolios of shares or bonds.
To make things even more confusing, there are 28 exchange traded notes (ETNs) available to trade in full-feature stockbroking accounts that are excluded from TFSA stockbroking accounts.
A key difference between ETFs and ETNs is that the former are policed by SA’s collective investment laws. Whereas a gold ETF has to physically own the bullion it represents, a gold ETN could synthetically track the price of gold through rolling over futures contracts. Since ETNs do not necessarily own what they claim to, they are regarded as too risky to be allowed in TFSAs.
A big advantage TFSAs have over pension products is that they are not constrained by rules limiting foreign shares and so forth. Your entire TFSA portfolio could be Deutsche Bank’s MSCI World Index tracker — a good choice, as it
offers the biggest diversity in terms of geography and the number of companies out of the available range of JSE-listed exchange traded products.
Again using Absa Stockbrokers as a reference, an advantage TFSAs have over full broking accounts is 0.2% brokerage, with no minimum or monthly fees. You do not have to pay dividend withholding tax, which now stands at a whopping 20%, or capital gains tax when you eventually sell.
The full-fledged account has 0.4% brokerage, with a minimum fee of R120 (excluding Vat), making transactions of a few hundred rand unviable.
Though my bias is towards ETFs, the selection of unit trusts available via Lisps is bigger, and I cannot claim to have researched all the Lisps out there to see if any offer lower fees than the big stockbrokers.
The war between ETFs and unit trusts has not been as heated in SA as in the US because there is a lot of over- lap between the players. The first ETF manager in SA, Satrix, was originally a subsidiary of the JSE. Prodded by other market entrants’ criticism that there was a conflict of interest, the JSE sold Satrix as a joint venture to Sanlam and Deutsche Bank. Nowadays, Satrix is wholly owned by Sanlam, which uses it as a brand for both ETFs and unit trusts.
Historically, ETFs were closely associated with index trackers — funds that build their portfolios by mechanically following stock market indices rather than having active managers select shares. The lines between ETFs and unit trusts have also become blurred, with most popular indices offered as unit trusts and a growing number of “smart beta” ETFs competing against actively managed unit trusts.
Sygnia CEO Magda Wierzycka previously argued that index trackers sold via Lisps offered a better deal than ETFs sold via stockbrokers. But now that Sygnia has entered the ETF market by acquiring Deutsche Bank’s range of JSE-listed foreign blue-chip trackers, she may switch allegiance.
A famous example of someone who switched from hero of active managers to ardent believer in index tracking is investment guru Warren Buffett.
“If a statue is ever erected to honour the person who has done the most for American investors, the hands-down choice should be Jack Bogle,” Buffett wrote in his most recent letter to Berkshire Hathaway shareholders. Bogle, the founder and former CEO of investment giant Vanguard, is considered the father of index tracking.
Buffett’s letter marked the conclusion of a bet that no hedge fund manager could beat Vanguard’s S&P 500 over 10 years. One hedge fund manager accepted Buffett’s challenge — and got soundly thrashed.
A common reason people mistrust index trackers is they offer average returns, and there is a popular misconception — even among people who have done university courses in statistics — that you have a 50% chance of beating the average.
To see why that is a fallacy, consider the average number of fingers of people in a largeenough crowd. Some unfortunate person is bound to have lost at least one finger. (This seems particularly common among famous guitarists — think of jazz legend Django Reinhardt, Black Sabbath’s Tony Iommi and the Grateful Dead’s Jerry Garcia.) Just as nearly everyone is likely to be above average measured by how many fingers they have, nearly all active fund managers are found to be below average measured by standard market cap-weighted indices over time. And the few active fund managers who do beat the average achieve this through blind luck rather than skill — something many people still refuse to believe, despite the overwhelming evidence.
TFSAs stand out as a good government initiative in educating people about investing and directing them to sensible products in the form of ETFs. But this assumes that people educate themselves enough to avoid the banks and insurance companies.
If you can afford to save more than R33,000 a year, Absa Stockbrokers (and I assume its competitors, too) let you link your TFSA to a fullfeatured broking account.
Some people see the R500,000 lifetime limit on TFSAs as an argument against opening such accounts, but I suspect that will be a moving horizon, with the limit lifted in future budgets.
Insurance product floggers have led people to believe bank TFSAs are the only type available