Recently a client mine asked me to help him design an investment strategy for his four children.
He wants to set up a portfolio for each child, to help them “Get Started” in life. As he put it, when they want to buy their first car, to put a deposit on a home, or even pay for a wedding.
His intention with this strategy is for long term growth, minimise taxation and keep fees low. Very common strategy for most investors.
He has four children, and he says that the average investment term will be 15 years. His questions to me were, what products should we use? What funds should we use? And what fees will apply?
Now this is where I must go through a process of elimination and discussion with the client.
What liquidity does he require from these investments? Is it only accessible in 15 years’ time or would he want to be able to access them prior? What investment return is he targeting? Because we need to make sure we align to what his expectation is and help him understand investment returns and investment risks.
Financial planning not simply making a blind recommendation, we need to consider a great deal of information, and then make a recommendation based on fact and not hype.
We also need to consider tax consequences. Will these investments be in his capacity or will he be setting them up for his children in their names? And then we need to look at affordability going forward. He is wanting to start off with a monthly contribution. Will we include an automatic annual increase in these contributions, or will he want us to review that annually and decide then? And does he want the ability to be able to add lump sums from time to time?
We then had a discussion around suitable product offerings and the products we considered outside of the banking space, because that’s not going to be suitable in this situation. We started with flexible investment accounts.
This is where we hold the unit trusts or the ETFs directly in our own name as investors. This option has the most liquidity, the highest flexibility, but is not necessarily the most tax efficient. Considering taxation is vital, as we want to ensure we maximise returns and minimise tax.
We then discussed and considered tax free savings accounts and both of us agreed these are not suitable in this situation as his children will more than likely want to use this money in the next 15 years or so. The real magic of a tax free savings account is that you invest for decades and leave it alone.
Next option to consider is an endowment policy (local and offshore) as these remove the tax liability from the investor. It is taxed within the endowment policy. There is an initial five-year contract there after it becomes what we call open ended or flexible, like I mentioned earlier.
He has no restrictions on where he can invest, local or offshore. What is further beneficial with an endowment is we can nominate beneficiaries. Now we’re having the discussion as to whether he holds the four endowments in his name and we nominate a child on each one or whether he puts these investments into his kids names individually.
Once we have unpacked and decided on the product or investment wrapper, we now get on to the fund selection.
The fund selection discussion is broad. In South Africa, we have around 1500 unit trusts and ETFs. Globally, there’s north of 17 500 options.
As you can see, to design an investment strategy should be a detailed approaching, considering all elements of investment design, investor behaviour, taxation, product selection and lastly fund selection.
This is not meant to be a comprehensive statement of what the process is when working with a financial planner and unpacking an investment goal like this client. But it gives you an idea of all the moving parts and where we need to consider them.
The value of advice with every element of your financial well-being is vitally important.
