? What is the best way to invest R5m

Cape Town – A Fin24 user who has R5m cash available seeks advice on the best investment for this cash to supplement his monthly income.

He writes: “I am 53 years of age and have been retrenched. I do have a R10m pension fund currently preserved which I will use to buy a living annuity at age 55.

“Also I have R5m cash available and my question is what is the best investment for this cash to supplement my monthly income? It must be tax efficient. I am considering a high dividend paying ETF.”

Jeremy Diviani, a CFP® Professional, of NFB Financial Services Group responds:

When one is looking at drawing an income from a lump sum there are various factors that need to be considered.

• The drawing rate, as a higher income you draw from the investment the more conservative one may need to invest.

• Linked to this is the need for growth assets and the allocation thereto. Growth assets are required to ensure inflation does not erode your real value of your money.  This may already be achieved inside your preservation fund.

• Taxation – there are various deductions and exemptions one can make use of for example a person under the age of 65 can earn R23 800 of interest or rental without paying any income tax. At the current money market rates this equates to roughly R360 000 invested before paying any income tax. You are also allowed R30 000 of capital gain before having to include a third in your taxable income. This allows for some growth assets like equities and listed property to be sold, if appropriate.

You mentioned a high dividend ETF (Exchange Traded Fund), this would entail a dividend which has the Dividend Withholding Tax of 15% (taxed at source). The dividend is then paid net of tax, but the share carries capital volatility.

These type of portfolios track the highest paying dividend shares typically in the Top40 and Mid cap shares. It is important to note that generally high dividend yielding shares have a value bias.

A value share is generally a share with a high dividend yield and a low Price Earnings multiple. The issue around these types of shares is that they have been some of the worst performing in recent years and may bring in greater capital volatility than one would want and expect.

An ETF by its nature has no active management and so will track the index indiscriminately. An example of this would be that the ETF would not choose between Vodacom and BHP Billiton, but hold both. When looking at the two, Vodacom has a yield of 4.53% and BHP Billiton 8.78%, however the capital risk between the two is very different and an active manager knowing that an income is being drawn from the portfolio may not hold Billiton and instead hold the more stable Vodacom.

With the uncertainty around the timing of the United States increasing interest rates and the impact it will have on stock markets globally, it might not pay someone looking for an income to take on riskier assets with the potential of capital loss.

Alternatives are preference shares. There are different types from your listed preference shares to your redeemable. The listed preference shares trade on the open market, but bring a certain amount of volatility.

Currently the Investec Limited preference share will give you a clean yield of 10.71%, this may seem attractive, but your listed preference shares trade at a premium and discount to par value and this brings in the opportunity of capital loss. They can also be very illiquid making it difficult to offload and so causing you to sell at a greater loss.

Redeemable preference shares are issued on the premise that the issuer will purchase them back at a certain time or event. These may offer a lower yield as the capital volatility is lower.

As mentioned above we will be entering a period of increasing interest rates and this impacts these instruments as the dividend is issued as a percentage of the prime lending rate. As rates go up you will be protected by a percentage of it and not the full rate increase as if you would have been in a floating rate instrument.

To gain access to the various securities one can look at direct securities portfolio, unit trusts or ETFs. With the volatility currently being experienced and this the order of the day for the short term, it is important to have a portfolio that matches your risk needs, is diversified and that can be amended as market conditions warrant it.

I would advocate a portfolio with active management and across various securities that may not necessarily be the most tax efficient like bonds and cash. It must also be flexible, so the risk can be increase or decrease should it be warranted. The level or percentage of each asset class will be determined by your income needs and your risk appetite.

As this cannot be construed as formal financial advice, it would be in your interests to contact a certified independent financial adviser, who will be able to conduct a full analysis on your financial position and goals and provide professional guidance with regards to your entire financial plan and risk profile

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