Question

I left university ten years ago and have been managing my own investments. After reading your column, I am concerned that this may not have been the wisest move and that my finances may be incorrectly structured which could cause problems in the future. 

I want to engage a financial advisor but don’t really know what questions to ask and I’m scared that I’m going to end up being sold unnecessary and expensive products.  Do you have any suggestions?

Answer

There are several moving parts when it comes to setting up a financial plan.  I will run through a couple of the main issues that you should address.

Protect your income

I find that many tend to go straight into investments without giving enough thought as to their ability to generate the income that will allow them to make future investments.  If you have an accident or become ill and not be able to work for an extended period, all your investment plans will grind to a halt.

I would therefore recommend that you check if your company offers you income protector cover that will pay you your salary should you be unable to work.  If you are self-employed, then I would recommend that you take out this cover in your own capacity. 

It is relatively inexpensive given the potential benefit.  I recently did a calculation for a 35 year old earning R50,000 a month.  If we assume that her salary increases by 6.5% a year and she gets no promotions then she would have earned an amount of R52m by the time she reaches retirement age of 65. That is the size of the risk that you are insuring when you take out income protection cover

Insure your income

Insurance brokers love to sell you life cover as the commission is generally very good and is paid upfront.

The question is how much cover do you actually need?  I work on the basis that you need cover to

• meet any debts that you may have
• insure your annual salaries until such times that your youngest child is off your hands – this is usually when the child is 25 years old.

Insider tip

If you don’t need much life cover now,  but do you see a need for cover in the future ( you may for example be wanting to buy a house or start a family in a couple of years’ time) then you should consider taking out future cover.  You get underwritten now, while you are young and healthy, for the cover in the future.  You can then take out cover without medical underwriting when you need it in the future.  You will pay a small premium for this benefit but it could pay dividends if you pick up any medical conditions in the future.  

Emergency fund

In my opinion, the first bit of saving that you should make would be to build up an emergency fund that is worth about three months’ of your gross income.  They should be invested in a portfolio that targets a return of inflation plus 2% and should be readily accessible.

Longer term investments

Once these structures are in place, you can consider investing in longer term investments.  These would include flexible investments like unit trusts as well as retirement savings like tax free investments and retirement annuities.

If your tax rate is higher than 30%, then you should consider using structures like endowments or sinking funds to house your long-term unit trust investments.  If you do this, your CGT liability will be a lot lower when you need to access these funds in the future.

When it comes to long term investments, I recommend that you aim to have a fairly equal split between your discretionary investments and your retirement investments.  This will give you a lot more options to structure your income at retirement in the most tax efficient manner. 

Offshore

I would further recommend that you split your flexible investments between South African based investments as well as investments made in a foreign currency offshore.  This will reduce the risk of having all your assets in South Africa.  It will also provide you with access to funds should you wish to spend any time overseas. 

I find that many retired people like to spend time with their overseas based children and grandchildren.  This can be expensive if the rand is doing badly when you travel.  By investing overseas while you build up the funds, the impact of the currency is reduced.

I would recommend that you discuss these elements of your financial plan with your financial adviser.