Your question is one that has been debated in the financial planning world for many years, and the reality is that there is no right or wrong answer.
Simply speaking, there are four traditional asset classes that are available to invest or store your wealth in – namely cash, bonds, property and equities.
Investors can either physically own those assets (by holding cash, purchasing government or corporate bonds, buying property or owning direct shares of listed companies) or invest in those asset classes ‘indirectly’ by owning units of a unit trust fund that invests in any one or a combination of those asset classes (i.e. invest in a unit trust fund).
When it comes to investing in property, you can either invest in tangible, brick-and-mortar property where you can own one or more properties for investment purposes – or you can invest in a property unit trust fund. The difference is that owning the property yourself means you are in control of every decision and aspect of the investment such as the size, geographical location, and type of property (e.g. residential or commercial). In addition, you are responsible for managing all the risks associated with physical property ownership such as maintenance cost, vacancy risk, rental legislation and liquidity risks, to name just a few.
On the other hand, if you were to invest in a property unit trust fund, you would typically own units in a fund that has exposure to various listed property companies, be it local or global. The return profile is based on the same economics, such as the capital value of the property plus the rental yield you receive from the property, but a unit trust fund offers a lot more diversification and liquidity compared with owning a single property in your own name.
An important factor that needs consideration is how you would fund such an investment. In order to purchase a physical property, it is likely that you would need to access finance through a bond facility, whereas banks will not lend investors money to invest in a unit trust portfolio.
Many investment property successes happen as a result of leveraging.
By qualifying for a bond, an investor is able to purchase a property and generate rental income (which they then use to pay off the bond), while at the same time building up equity in the property or the access bond – all of which serves to qualify the investor for higher levels of financing with which to purchase the next property, and so on. Eventually, the investor has an investment property portfolio which provides them with annuity rental income – although keep in mind that this investment strategy is not without risks.
Bond repayments will be due at the end of every month – regardless of whether your tenant has paid their rent or not.
Your ability to cover the maintenance costs, property vacancy, and monthly rates and levies are just some of the considerations you should make before purchasing an investment property. Remember also that you will need to have sufficient funds available to cover all the upfront costs involved in purchasing an investment property.
A consideration to make when investing towards retirement is that of diversification – not only within an asset class, but across all asset classes – as well as diversification in types of investment vehicles used for retirement. There are times when asset classes, both local and global, perform well, and times when they perform poorly.
The table below shows the average returns of the various asset classes over one-year periods looking back to 2007.
The volatility of each asset class highlights the need for long-term investors to not make knee-jerk reactions to market fluctuations, but to have a diverse investment portfolio.
When it comes to selecting the type of investment vehicle to use, keep in mind that retirement annuities are designed specifically for retirement savings purposes, allowing you to claim contributions as a tax deduction. Legislation permits you to deduct up to 27.5% of gross annual taxable income capped at R350 000 per year.
For instance, let’s assume that you have an additional gross income of R10 000 per month to save. Your marginal tax rate is 41%. You are deciding between investing towards a retirement annuity or purchasing an investment property. If you purchase a property, you will have an after-tax amount of R5 900 per month to invest towards this purpose. On the other hand, you would be able to invest the full R10 000 per month into your retirement annuity as it is a tax-deductible contribution. There are of course rules and regulations around retirement annuities and how you access those funds at retirement.
As is evident from the above, there are advantages and disadvantages to both approaches and it is not uncommon for investors to implement a blended approach to retirement savings by maximising their retirement annuity contributions, creating liquidity options by investing in a discretionary unit trust and a tax-free saving account, and holding an investment property if it interests them.
To build a robust investment plan for retirement, it is advisable to engage with your financial advisor to help you make well-informed investment decisions so that together you construct a plan that suits your needs and objectives.