Beata Carstens, a certified financial planner from Veritas Wealth, explains that deciding on the best vehicle for your hard-earned money ultimately depends on your investment goals.
There is such a plethora of investment options available on the market these days that it is often difficult to know what the best choice is for you. As with any investment, you want the best returns with the lowest risk. Here are three classic investment dilemmas:
Student policy or unit trusts for education?
When looking to invest money for your children’s education I would advise that you make use of a unit trust investment because of the flexibility of the investment, its relatively lower and more transparent costs, and its liquidity.
A student policy is effectively an endowment policy with a fixed term, fixed cost structure and a fixed contribution pattern. Should any of these factors change during the investment period, you will incur penalties that will come out of the value of the policy.
A potential benefit is that risk cover can be added to a student policy. For instance in the event of the death of the person paying into it, the rest of the monthly premiums will be paid by the life company. The downside of this, however, is that part of the monthly premium is utilised to pay for this cover and only the remainder is invested. Determining how much of the premium goes towards risk cover and how much is actually invested could be a rather grey area, because the risk premium can change over time.
My advice would rather be to include provision for your child’s education in your overall risk plan. With a unit trust investment, you are not held to contributing a fixed amount every month, so if something happens and you miss a payment, the value of your investment will not be affected.
You are also able to withdraw from a unit trust at any time without incurring any penalties. Of course this means you have to be disciplined enough not to take money out for any other purpose besides your child’s education, but you are also free to choose when and how you access it.
Unit trusts or directly into stocks?
Investing successfully in the stock market takes a lot of time, knowledge, discipline, capital and the ability to detach yourself emotionally from the shares in your portfolio. If you are able to do all of this and you can time the market, you will be able to deliver superior returns compared to mutual fund managers.
However, investing in a unit trust gives you access to the time, knowledge and discipline of fund managers who – theoretically at least – are experts in this area. It also offers you exposure to a broad range of stocks for a relatively small amount of money. This means you can build your position by adding ad-hoc amounts or monthly premiums over time without having to pay potentially high brokerage fees on every transaction. Research has shown that very few investors can honestly claim that they are successful at selling high and buying low. Nobody really knows how the market will perform, and successful investors rather look for cheap stocks with prospects of increasing their value over time. Having said this, a lot of time should be spent on understanding why the stock is cheap and to determine whether the stock has the “legs” to improve its standing in the market over time.
From a cost point of view, a mutual fund with the mandate to invest only in stocks should cost you less than 2% per annum, whereas you will have only brokerage fees should you manage your own portfolio. The question of course is whether you will be able to outperform a mutual fund by at least 2% pa consistently to justify doing it on your own.
Certificate deposit or a money market fund?
Certificate deposits have a fixed term and usually a fixed interest rate. The amount of money you are investing in the certificate deposit and the term you are investing for generally influence the interest rate the bank will pay you. A money market fund invests in short-term, highly liquid money market instruments with a maturity of less than 13 months. These instruments can be issued by government, parastatals, corporates and banks.
The main differences between certificate deposits and money market funds are the investment term, variation in the interest rates and costs. With certificate deposits you can choose from the outset what your investment period will be and you know that at the end of the period you will receive your initial capital back together with the interest received at a fixed interest rate.
An investment in a money market fund on the other hand is very liquid. You can invest today and withdraw the money tomorrow. However, the interest rate you receive on your investment varies according to the ruling interest rates over time and will move in line with the market rates as determined by the Reserve Bank. So you don’t know at the start what your rate will be. It could end up either higher or lower than where it is at the start.
Depending on the amount to be invested in a money market fund, there could also be initial investment costs involved. Money market funds charge an ongoing fee and one should bear this in mind when determining the interest rate quoted. There are no hidden costs in the case of certificate deposits. Deciding which type of investment vehicle is best for you requires that you know their characteristics and why they may be suitable for a particular investing objective.
If all of this seems a bit too bewildering and complex, I would recommend that you chat to a certified financial planner, who should be able to help you identify your investment goals and guide you along the right path.