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Congratulations on your lottery win. I also want to applaud you for reaching out for investment advice. I scoured the internet, and it seems that approximately 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 on spending the money within the next 18 months, I think a fixed deposit is not the optimal place for you to be. Currently, the return on cash is below inflation, which means that 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 whittle away. This is currently a broad problem in South Africa, with around R1.6 trillion in cash and similar.
In the following chart, whenever the black line is below the blue line, the inflation rate is above the repo rate. (The repo rate is the rate at which the SA Reserve Bank (Sarb) lends money to commercial banks). Credit interest rates in a bank account are almost always less than the repo rate.
As your money is in a fixed deposit, you should be achieving a return above a daily call account. Does this then negate my points above?
A three-month fixed deposit currently pays interest of approximately 5.5% per annum, which is above the current inflation rate. An essential consideration is tax. Interest income, whether received or accrued, is taxable. If you have an average tax rate of 20%, the net return of a 5.5% return reduces to 4.4%, and now you are below inflation.
If we keep using our three-year fixed deposit as a reference point, a further 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% (per the chart above), the difference between the two is 0.9% (I’m discarding tax 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 by locking in your money. If interest rates, for example, increased by 1.5% over the next 12 months, the three-year fixed deposit rate could go to 7%, but you would be locked to 5.5%. As the gap between the inflation rate and the fixed deposit rate is low, with the market also predicting increases in the interest rate, the concept of ‘opportunity costs’ needs to 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 amended implied policy path of the Sarb’s Quarterly Projection Model (QPM) now indicates a repo rate increase of 25 bps in 2021q4 (fourth quarter) and in each quarter of 2022. […] The risk is that should the fiscal outlook further deteriorate, and we have persistent currency weakness, the Sarb may need to consider a more aggressive hiking pace.”
If this is correct, locking into a long rate now that does not provide a sufficient cushion could be disadvantageous.
Investments need to move beyond cash
The next consideration is where you will get your best long-term return. Savings (for short-term needs such as holidays) can be left in cash, but investments need to move beyond cash to achieve a better long-term return.
The following table compares the return on different assets 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% |
| SA inflation | 4.87% | 3.85% | 4.24% | 4.98% |
| MSCI World NR USD | 16.04% | 18.79% | 15.52% | 20.05% |
Source: Nedgroup Investments/Morningstar Direct
Data as at July 31, measured in rands
Don’t pay too much attention to the one-year returns. Firstly, the period is very short, and, secondly, the figures are a bit misleading coming off the Covid market lows – in other words, the returns look seriously good.
What the table does show, however, are the good long-term returns achievable by investing outside of cash.
Investing outside of cash does introduce more risk, particularly volatility risk. But the longer your investment timeframe is, the lower the risk becomes.
Let us look at the rand benefit of earning a few extra percent per year:
Example 1
Invest R3 million for 10 years earning the STeFI Call Deposit rate. The investment value after year 10 is R5 212 539.
Example 2
Invest R3 million into 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 111 640.
In the examples above, the difference in the 10-year values is staggering and shows the benefit of taking on appropriate risk. The amount of risk you can take on will be influenced by factors such as your age, asset base, future liquidity requirements and personal attitude to risk.
You have not given us any information about yourself, so we cannot attempt to provide you with any ideas around the type of products and funds – unit trusts, exchange-traded funds (ETFs), shares and so on – that you could consider.
Given the high rate of lottery winners losing all their winnings, we suggest you seek professional advice.
If possible, do not let the lottery win lead to increases in your lifestyle costs.
Instead, let it provide comfort to you by knowing you have a safety net and a boost to your retirement plan.
Good luck!
As an expert in financial planning and investment strategy, I appreciate your proactive approach to seeking advice after winning the lottery. It's commendable that you are aware of the potential pitfalls that many lottery winners face, with a significant percentage losing their fortunes or going bankrupt. This demonstrates a keen awareness of the challenges associated with sudden wealth.
Let's delve into the key concepts discussed in the article:
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Fixed Deposit Consideration:
- The article mentions that a fixed deposit might not be the optimal choice for your winnings, especially if you don't plan to spend the money within the next 18 months. The return on cash is highlighted as being below inflation, which means the real value of money in the bank is decreasing.
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Interest Rates and Inflation:
- The article emphasizes the importance of achieving a return on investment higher than inflation to preserve the purchasing power of your money. It introduces the concept of the repo rate, the rate at which the South African Reserve Bank lends money to commercial banks.
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Tax Implications:
- Tax considerations are brought into the discussion, noting that interest income from a fixed deposit is taxable. The net return is adjusted based on the average tax rate, and this adjustment can impact the overall returns on your investment.
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Opportunity Costs:
- The article discusses the concept of opportunity costs concerning locking in money at a fixed rate. If interest rates increase beyond the rate of your fixed deposit, there is a potential opportunity cost as your money is locked in at a lower rate.
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Market Predictions and Economic Outlook:
- Quoting information from Nedgroup Investments Cash Solutions, the article mentions the implied policy path of the South African Reserve Bank and the potential impact of fiscal outlook and currency weakness on interest rate decisions.
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Diversification and Long-Term Returns:
- The importance of moving beyond cash for long-term returns is highlighted. The article provides a table comparing returns on different asset classes over various time periods, emphasizing the benefits of investing outside of cash for better long-term returns.
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Risk and Investment Timeframe:
- The article acknowledges that investing outside of cash introduces more risk, particularly volatility risk. However, it emphasizes that the longer the investment timeframe, the lower the risk becomes.
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Illustrative Examples:
- Two examples are provided to illustrate the potential difference in investment values over a 10-year period based on different investment approaches, emphasizing the benefits of taking on appropriate risk.
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Professional Advice:
- Given the high rate of lottery winners losing their winnings, the article strongly recommends seeking professional advice. It also encourages not letting the lottery win lead to an increase in lifestyle costs but rather using it as a safety net and a boost to retirement planning.
In conclusion, the article provides a comprehensive overview of various financial concepts and considerations, tailored to the context of a lottery win. It emphasizes the need for careful planning, awareness of market conditions, and seeking professional advice to make informed investment decisions.
