YOUR MONEY: How to phase out of cash

Question:

I have been enjoying the relatively high interest rates offered by banks on their saving account products. I am not at the stage of my life where I want to take big chances on the stock markets. Is there any way of protecting my savings and my interest flows, given the likelihood of interest rate cuts?

— Anonymous

Answer:

When it comes to structuring a well-diversified all-weather portfolio, one asset class should not be seen as an alternative to another. Asset classes play different roles in a portfolio and behave differently through economic and market cycles.

It’s understandable if you do not feel the need to take on too much volatility, but defining risk is also important when it comes to our portfolios. The stock market is volatile in nature, but volatility can be managed within a portfolio with optimal asset allocation. It is just something to be aware of. This high interest rate cycle has been incredible for cash and bonds — and it’s not over yet, as a rate-cutting cycle typically does not happen overnight.

Even so, there are a few factors that need to be considered when we have mainly cash exposure:

• We need to outperform (or at least keep up) with actual inflation. This refers to your real cost of living. A good starting point is annual medical aid increases, which are closer to an average of 9%. If interest rates start dropping, this essentially means your yield on cash will be less than this, and you are losing buying power daily.
• Your fund value invested in cash (and bonds). These are interest-bearing asset classes and essentially an income. Beyond your annual exclusions on interest earned, you will be taxed at your marginal rate over and above this. This can have a negative tax effect if not structured optimally.
• Estate planning. If these funds are liquid, it will go to your estate. Out of a taxation and timeline point of view for your dependants, I would recommend finding more optimal vehicles, such as the use of an endowment/sinking fund where you could limit income tax to 30%, and ensure a beneficiary nomination can address this.
• Overall return. The main objective with wealth management, and even more so within the retirement phase, is to outperform inflation, and your income needs to ensure you won’t erode capital earlier than planned. We don’t want to outlive our funds. A well-diversified portfolio consisting of various asset classes (not just equities) had a return of 12%-14% over the past year. This adds significant years to your capital.

I would recommend phasing out of cash slightly as rates are cut over the next 12 to 18 months. Even just combining some bond exposure and some equity (it does not have to be an all-or-nothing approach), will minimise risk, ensure higher returns and decrease taxation implications. Asset allocation can be strategically managed by a wealth adviser to minimise risk and volatility and make you feel comfortable, though at the same time ensuring desired outcomes are met.

— Elke Brink is a wealth adviser at R21 Wealth Management, Stellenbosch

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