The Vehicles for Your Investment Journey
Our investment journey starts from as early as our first paycheck. To help navigate the confusing and seemingly infinite number of investment vehicles out there to tackle this journey, it is useful to think of these investment vehicles and the way they operate as actual vehicles on a physical journey.
Just as the right car for a particular person depends on the terrain, their budget, the load that needs to be transported, or the end destination, the most appropriate investment vehicle for any person also depends on their circumstances and will probably change as they go through life’s many stages.
A motorbike may be a perfect vehicle to get you to work and back in your early 20s while you are saving up for a hatchback, but you will probably need a family van parked in the garage when baby number three is on the way. When the children are all grown-up and out of your house – and pockets – you might want to trade in the van for a sports car.
Investment vehicles, or products, can be considered as the ‘shell’ that an investment is held in. Providers of these products usually report monthly or quarterly returns, and issue tax certificates of your investments on a product-by-product level. You may have many different products with the same product provider.
A truck may have eight wheels while a bike has two. A bus may seat 25 people while a car seats five. You may fit loads of bags into an SUV and only one suitcase into a hatchback. Just as vehicles have many different characteristics that all suit different needs, investment vehicles also have their own unique characteristics, each to suit different needs.
Some products are more liquid, meaning you can have access to the funds in your investment within as little as a day, whereas others can take months or even years to withdraw from. Some products have a high risk associated with them, with the intention to increase their return, while others may have lower overall risk, thus, increasing your investment’s stability but offering lower returns.
Other characteristics are the way in which taxes are treated within these vehicles as some will increase your taxable income while others can be liable for Capital Gains Taxes (CGT) or even, in some cases, donations tax.
A few examples of investment vehicles are bank accounts, unit trusts, pension funds, hedge funds, tax-free savings accounts, endowments or ETF (exchange-traded funds), to name but a few. In the series of articles to follow, these investment vehicles will be discussed in more detail with examples, details about their characteristics and considerations on which products are appropriate for determined life stages and circumstances.
In the same way that BMW, Volkswagen and Audi are manufacturers of vehicles, Sanlam, Liberty, Discovery, Allan Gray, and most commercial banks, to name only a few, are the product providers in the financial world.
All cars have a steering wheel, radiator and brakes, but each manufacturer customises the design, the price and the extra luxuries of the vehicles they offer. In the same way, providers of investment products may offer standard products such as unit trusts, but the available underlying investments, fees, fact sheets, events, systems and communication channels are some of the aspects providers use to customise their product and the experience of owning their product.
Car manufacturers may sometimes outsource a certain function of their business to a third party. In the same way, product providers may outsource certain functions that are part of their offering, such as system development, administration services or event management. For clarification, systems are important for investment products as they offer records of the underlying investment of each investor, they can track price movements and they offer the required data for reporting and tax purposes.
Cars are usually sold by car dealerships and you will have a salesman responsible for helping you choose which vehicle is one the best suited to your needs. As with car dealers, we also get “dealers” that help individuals choose which investment product (“vehicle”) is best suited for their financial needs.
These “dealers” are referred to as brokers in the financial industry and they usually have broker codes with the product providers “vehicle manufacturers” which means they are authorised to “sell” the products of these product providers. These brokers usually have in-depth knowledge of certain products and receive commissions from the product providers for the products that they sell. These dealers work on behalf of a financial advisory company, formally known as the financial services provider (FSP) and the brokers are representatives of these FSPs.
Although brokers play an important role in helping individuals understand complex products, it is important to be aware that often, these brokers only sell a few product providers’ products and that they might not be aware of other products that might possibly better suit a client’s needs. There are also other FSPs that are known as independent product providers that have codes with a wide base of product providers and are thus better placed to help a client to find a more suitable product.
Cargo and passengers
The purpose of vehicles is to transport goods and people and each vehicle is specifically designed with its purpose in mind. Some trucks transport bricks and others are made to carry livestock. In the investment world, the cargo and passengers that are put into vehicles are known as the underlying investment and are grouped into asset classes. A bank account, for example, is the vehicle, while the cash in that account is the cargo.
The underlying investment is the actual thing that is bought with the investor’s money with the purpose of selling it again at a profit. Just as cash is the underlying investment that gets held in a bank account, we also have a few other types of “cargo” that are categorised based on their liquidity, risk associated with the type of investment, and geographic location, to name but a few types of categories used to group investment types together.
The most commonly used underlying investment is shares in a public company that are available on a stock exchange, such as the JSE. These shares can then be held locally or they can be international shares. We also get Forex (i.e. “foreign exchange”) investments, which means currencies, such as dollars or euros, are bought, held and traded with the goal of selling them at a profit.
Another popular investment is debt instruments which are used by businesses and governments to raise capital. The investor will lend a lump sum to the business or government (a.k.a. the borrower) with the agreement that the borrower will repay the lump sum along with an additional interest lump sum on an agreed further date. The most common debt instruments are government bonds.
Last but not least, are the rulemakers, the law enforcers, and the ones that make sure the public is kept safe. Just as the metro police make sure that rules of the road are followed, there are also authorities in the financial sector to make sure that the important rules are followed with the goal of keeping the general public safe.
These authorities are the Financial Sector Conduct Authority (FSCA) and The South African Reserve Bank (SARB). The FSCA is responsible for supervising all FSPs, while SARB is responsible for overseeing all activities of banks. SARB is also responsible for enforcing and monitoring exchange controls when people consider exchanging rands for another currency.
These authorities make sure that product providers do not take advantage of vulnerable investors that might not understand the product, industry or underlying investment. There are various measures put in place regarding what and how providers may advertise their products to ensure they are not misleading, and also how often they need to communicate with their clients.
There are also strict rules regarding what “advice” is and who is allowed to give financial advice, what processes need to be followed when replacing a policy and for how long records need to be kept of important information such as statements and communication.
So before jumping into your investment vehicle and driving off into the sunset of your financial journey, make sure you understand all the role players and where what fits into the industry. This will allow you to ask the right questions and ultimately make the most informed investment decision.