Please note that the information provided below does not constitute financial advice; in fact, we cannot give specific advice. Generic information has been provided given the context of your question. We have limited details about you and your circumstances, and knowing more details may affect any advice provided.
Congratulations on winning the lottery. I also want to applaud you for asking for investment advice. I searched the internet and it appears that roughly 45% to 75% of lottery winners lose their fortune and / or go bankrupt. With this in mind, you are off to a good start in seeking advice!
Unless you plan to spend the money within the next 18 months, I think a fixed deposit is not the optimal place for you. Currently, the return on cash is below inflation, which means that the money in the bank is losing value in real terms. If you cannot achieve a return on investment of at least inflation, then the purchasing power of your money will be reduced. This is a vast problem in South Africa today, with around R 1.6 trillion in cash and the like.
In the graph below, whenever the black line is below the blue line, the inflation rate is above the buyback rate. (The buyback rate is the rate at which the SA Reserve Bank (Sarb) lends money to commercial banks.) Interest rates on credit on a bank account are almost always less than the buyback rate.
Since your money is in a fixed deposit, you should outperform a daily calling account. Does this then negate my previous points?
A three-month fixed deposit currently pays interest of about 5.5% per year, which is above the current inflation rate. A key consideration is taxes. Interest income, whether received or earned, is taxable. If you have an average tax rate of 20%, the net return on a 5.5% return drops to 4.4% and is now below inflation.
If we continue to use our three-year fixed deposit as a benchmark, an additional consideration is the gap between inflation and the interest rate received. Based on a fixed deposit rate of 5.5% and an inflation rate of 4.6% (based on the chart above), the difference between the two is 0.9% (I am discarding taxes for this point). If the inflation rate stays constant and interest rates increase by more than 0.9% over the next three years, you may have an opportunity cost in locking your money. If interest rates, for example, were to increase by 1.5% over the next 12 months, the three-year fixed deposit rate could reach 7%, but you would be locked in at 5.5%. Since the gap between the inflation rate and the fixed deposit rate is low, and the market also predicts increases in the interest rate, the concept of “opportunity costs” must be carefully considered.
At this point, I am going to quote from an article I received from Nedgroup Investments Cash Solutions published on August 19: “The modified implicit policy path of Sarb’s quarterly projection model (QPM) now indicates a repurchase rate increase of 25 bp in 2021q4 (fourth quarter) and in each quarter of 2022. […] The risk is that if the fiscal outlook deteriorates further and we have persistent currency weakness, the Sarb may have to consider a more aggressive rate of rise. “
If this is correct, blocking a long rate now that it does not provide a sufficient mattress could be a disadvantage.
Investments must go beyond cash
The next consideration is where you will get your best performance in the long run. Savings (for short-term needs, such as vacations) can be left in cash, but investments must go beyond cash to achieve better long-term returns.
The following table compares the performance of different asset classes over four periods.
|1 year||3 years||5 years||10 years|
|FTSE / JSE All Share Index||27.06%||9.67%||8.75%||11.60%|
|BEASSA All Bond Index||13.92%||8.67%||8.87%||8.46%|
|STeFI Call Deposit||3.51%||5.30%||5.91%||5.68%|
|MSCI World NR USD||16.04%||18.79%||15.52%||20.05%|
Source: Nedgroup Investments / Morningstar Direct
Data as of July 31, measured in rands
Don’t pay too much attention to one-year returns. First, the period is very short, and second, the figures are a bit misleading derived from Covid market lows; in other words, the returns look very good.
However, what the table does show is the good long-term returns that can be achieved by investing outside of cash.
Investing out of cash introduces more risk, particularly volatility risk. But the longer the term of your investment, the lower the risk.
Let’s look at the rand benefit of earning a small additional percentage per year:
Invest R3 million for 10 years getting the STeFI call deposit rate. The investment value after year 10 is R5 212 539.
Invest R3 million in the following portfolio, which broadly resembles a balanced investment:
- 40% FTSE / JSE All Share Index
- 20% MSCI World NR USD
- 30% BEASSA All Bond Index
- 10% STeFI call deposit
The investment value after year 10 is R9 111640.
In the above examples, the difference in the 10-year values is staggering and shows the benefit of taking the right risk. The amount of risk you can take will depend on factors such as your age, asset base, future liquidity requirements, and personal attitude to risk.
You have not provided us with any information about yourself, so we cannot attempt to provide you with any insight into the type of products and funds (unit trusts, exchange-traded funds (ETFs), stocks, etc.) that you might consider.
Given the high rate of lottery winners losing all of their winnings, we suggest that you seek professional advice.
If possible, don’t let the lottery add to your lifestyle costs.
Instead, let me give you comfort in knowing that you have a safety net and a boost for your retirement plan.