Investing in a tax-free savings account (TFSA) should be the first port of call for any first-time investor, but how do you choose which TFSA is right for you? Wessel Brand, Portfolio Manager at Sygnia Asset Management, has the answer.
Investing in a tax-free savings account (TFSA) should be the first port of call for any first-time investor, but how do you choose which TFSA is right for you? Wessel Brand, Portfolio Manager at Sygnia Asset Management, has the answer.
In Part 1, I covered why TFSAs should be the first account any new investor opens. Building on this, I’ll outline five ways to choose the TFSA that’s right for you.
1 | Invest for your age
In general, your age determines your investment risk profile: the younger you are, the more risk you can take; the older you are, the less risk you can take.
While markets rise over time, it doesn’t happen in a straight line – there are many ups and downs along the way. If your investment timeline is longer, you can afford to take occasional losses, because they will invariably be made up by long-term gains. If you’re older, however, you will not want to take a big loss just before retirement.
This is why selecting a TFSA with low, medium or high risk according to your age is important. For example: in your 20s and 30s you can go high risk; in your 40s and 50s choose medium risk; and in your 60s stick with low risk.
2 | Select according to your risk
The type of asset that underpins your TFSA should also be based on your age risk profile, as different asset classes carry different risk levels.
For example, if you’re young you might invest in higher risk exchange traded funds (ETFs). If you’re older, you might choose low-risk index funds with wider exposure to the markets. These funds offer added security by being regulated by regulation 28, meaning they must be managed according to the investor’s best interests in terms of risk.
3 | Factor in fees
No matter what level of risk you take, always ensure you pay the lowest possible fees – up to a maximum of 0.5%, unless it’s a specialised index fund.
High fees chomp away at your returns over time: a report by South Africa’s Treasury a few years back found that an investor paying 2.5% instead of 0.5% in fees will lose up to 60% of their retirement savings over a 40-year period.
Bottom line: if you want to maximise your tax-free investment over time, avoid high fees like the plague.
4 | Avoid fixed interest vehicles
Most banks offer money market or other types of fixed interest accounts as TFSAs, but investing in these types of accounts is a waste of your tax-free investment allocation.
With an interest-bearing fund, your only form of growth is interest, so the capital invested will stay more or less the same over time. With the only added value being the fixed interest earned, there is no way your capital investment will grow aggressively.
Furthermore, interest earned on fixed interest accounts is regarded as tax-free up to R23 800, regardless of whether it’s a TFSA or not. Unless you have about R350 000 to R450 000 invested, you won’t hit that annual interest cap. Putting your tax-free allowance into a fixed interest account is a waste of an opportunity to invest in a market growth-related TFSA that can deliver better returns over the long term.
5 | Know your appetite for risk
While low-risk TFSAs naturally have less volatility than high-risk TFSAs, every fund has a level of market volatility.
The trick is to know yourself and to select a TFSA according to your ability to ride the ups and downs. For example, if you are young enough to invest in high-risk funds but get stressed out by unexpected financial changes, it might be better for you to choose a low- to medium-risk TFSA.
Those are the five most important considerations when selecting a TFSA that suits your personality and your investment goals, but there’s one more important thing to bear in mind: tax-free investing is not a short-term strategy, and no investment will grow in a straight upward line. To maximise the returns on your tax-free savings allowance, you have to be in it for the long term: commit to the TFSA you’ve chosen and then forget about it until you’re ready to cash out. With tax-free investing it’s all about time in the market, not timing the market.