Our government really doesn’t want us to invest locally

Dear Investor Challenge,

We really need investment in South Africa. It’ll create jobs, stimulate the economy and drive innovation which could one day cure AIDS, Malaria and Cancer. It’ll even end the current scourge of crime we’re suffering so much under. But be warned, as fantastic as that sounds, if you do invest in South Africa I’m going to punish you.

Yes, I’m going to punish you, hard. And not in the 50 shades kind of way but really miserable pain. Exclusively to your rear pocket, where you carry your already heavily punished wallet. Of course I will still punish you for investing internationally, but it’ll be so much worse if you keep your money in SA.

But please, ignore the fact that keeping all your investments here is bad for your wealth, terrible diversification and completely ignores the efficient market hypothesis, just invest locally, it’s the right thing to do. Like paying your TV license so Hlaudi can get his next bonus or raise. Or both.

Thanks,

The South African Revenue Service.

Well that was motivational. It’s also true, apart from our R30 000 a year that we can put into our tax free savings accounts, our government actually doesn’t want us to invest locally. If they did, they wouldn’t punish us for doing just that. In fact we are punished FAR more for investing in South Africa than we are for investing outside of South Africa.

If you’re thinking it’s got anything to do with the idiotic policies government keeps coming up with, or the way one part of the ANC is fighting with the other so that it can keep draining wealth from the taxpayers to themselves think again. It also has nothing to do with the fact that we could be staring a recession, and maybe also a ratings downgrade into the face.

This time it’s all about mathematics. Maths doesn’t have any grey areas, and you can’t argue your way out of a wrong answer. It doesn’t lie, or make claims that can’t be proven, and because it didn’t require me putting in countless hours trying to memorise things, it was one of my favourite subjects in school. So what does this have to do with investing either locally or overseas?

It all comes down to whaStripping is more profitable than mathst is called Capital Gains Tax (CGT). I say called because in reality capital gains tax has far more to do with inflation than it does with capital gains as I’m hoping to prove soon with an example.

In this example we’re going to assume two things. The first is that you have one million rand to invest. The second thing we’re going to assume is that you don’t read this blog very often, and don’t bother doing any research before you invest. If you had read this blog you would have come across my articles here and here moaning about how poor my returns had been in the property market. I always get arguments in the comments of those posts, but if you had done any research, you would have found that on average, property barely increases in value any faster than inflation.

And now a number of you property investors are already planning on jumping right down to the comment section to give me a piece of your mind, which I really don’t mind as it means at least someone reads these posts, but before you do you should probably ready this study on how the US property market only increased by 0.1% per year over inflation between 1900 and 2012. Still want to argue? Then please read about the Herengracht index. Thanks to the supremely anal record keeping of the dutch, a finance professor in Holland was able to compile the Herengracht index on a very special section of real estate.

The property along the Herengracht canal in Amsterdam has been THE property to have since it was first built in 1628. Unlike Sea Point, Hillbrow or the famous Eloff street which has the prime spot on the Monopoly board, this stretch of land never went out of fashion. The study at first looked at the time from 1628 to 1973, but later extended the period to 2008. Guess what happened in that time? Well the real value of the property doubled. Sounds good doesn’t it? The problem is, it took 380 years to double, meaning the annual growth rate was just 0.1% above inflation yet again!

Do you see where I’m going with this? If you take the average growth of property, and then add the expensive costs for buying and selling, you’ll be lucky to end up with any real growth at all. Add in the maintenance costs, and the ever increasing rates and taxes, and you’ll be lucky to avoid negative real growth. This will make my calculations a lot more simple as I can assume a 0% real growth, and that can take me back to the the real point in this post.

There are many reasons why I don’t like Capital gains tax. It is double taxation, the money I use to invest has already been taxed, it also discourages investment, but to me, the #1 problem with capital gains tax is that it is not indexed for inflation. This means that you’ll pay CGT on real growth, and you’ll pay CGT on growth purely due to inflation.

So what would happen if you invested in a property in South Africa worth a R1 million only to sell if 20 years later? Take a look at the table below:

CGT to pay on R1 million over 20 years

CGT to pay on R1 million over 20 years

What I’ve done above is increase the value of the property by 6%, the same as inflation. That’s the reason the second column never changes it’s value. In real terms this property hasn’t gone up at all, yet after 20 years you’re still forced to hand over R355k to SARS on what they call capital gains tax, but what is in reality just a tax on inflation. I don’t think that’s really fair considering the fact that the government is one of the main causes for the inflation.

Now let’s take the same value of R1 million, and invest it in a currency with far lower inflation, the US dollar. Sure we still have to abide by the stupid non-inflation indexed tax laws, but because the inflation rate there much lower, the effect of inflation is far lower too:

CGT to pay on R1 million converted to dollars over 20 years

CGT to pay on R1 million converted to dollars over 20 years

In this table we took the R1 million, converted it to dollars and then bought a property overseas. Again the only increase in value is from inflation, this time at 2%. Then to be able to back convert, we’re assuming the rand/dollar rate will weaken at something called the inflation differential, basically the difference between SA inflation and US inflation, which is 4%. Thanks to a changing of foreign investment laws in 2011, this time after 20 years we only need to pay Tom Moyane and pals R168k, less than half of what we’d have to pay him if we bought the property in South Africa.

The outcome is similar for stock market investments, but at least with those you do get actual real growth. Now I’m not sure about you, but I’d rather not pay twice as much in tax if I can avoid it, which is another reason why, apart from my tax free savings account, all my investments are going offshore.

If you’re worried about this and think I’m being very unpatriotic, see if you can get SARS to index capital gains to inflation. If they don’t listen, don’t worry too much, because to ease your concerns I can tell you there is really no problem at all.

As it is now an undeniable fact that you can’t beat the market by picking shares or picking economies, more and more people are doing with their money what science says they should do and are investing in the whole world. This means that hundreds of millions of people who haven’t heard of South Africa, or who think it’s a region rather than a country are now putting 0.74% of all their investments into South Africa. I’m one of them too. Putting 0.74% into SA of course, not one that thinks it’s a region.

And there’s more good news. This 0.74% number can increase, as it’s based on the percentage of the global market that is held by South Africa. In other words if the South African economy grows, the percentage people invest in South Africa will grow too. Sadly if our economy shrinks, people will invest less in us.

Hopefully this will be motivation for our government to do the right thing by focusing on growth policies rather than ways to lie, steal and cheat people out of money. I know, it means putting other people first, something which isn’t really a requirement in our current state of politics, but hopefully the voters will keep moving in the right direction with their choices.

Note: If you really do want to invest purely in South Africa, there is a way you can do that and still pay less in CGT than you would normally. By buying the iShares MSCI South Africa ETF you can invest in the top 60 or so South African companies using US dollars. This means when you do eventually sell, you’ll only pay CGT on 2% inflation rather than on 6%.

Are we still arguing about the benefits of property investment?

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  • Bokkeman

    All good info, but your poll should have a fourth option: “I have the luck of the devil and somehow always invest in property at the right time to see multiples of growth” 🙂
    I was lucky enough to invest in Hout Bay property before the oughties boom and saw 2.5x growth over about 4 years, and more recently I purchases a house in a desirable small Western Cape town and have easily seen the value of my property double over the past 4 years. The problem with these long term studies (and most other ones) is that they measure only in the aggregate and on average, while there are indubitable opportunities for arbitrage on the small scale – the luck and skill comes in reading the trends and exploiting those margins.
    Another example: you might turn away from the beach in disgust, surfboard under your arm, at the sight of a sea which you consider as smooth and glassy as a mirror – yet if you were an ant on a leaf on that same ocean it will appear to have as many violent ups and downs as any other day, at a scale that matters to you…
    At the risk of belaboring my point, another factoid: at every cross section point in a stream, no matter how vigorously it flows, there will be a place where water flows BACK upstream. We can be like the fish that look for and exploit those counter-currents, and swim effortlessly “upstream.”

  • Brian Whistler

    Patrick you have your finger on the pulse of the zeitgeist. good article as usual

  • Yes good point. You and my mother would definitely qualify for that. She built a house for R1m cost that today (15 years later) is worth R4m, bought a beachfront apartment for R670k, today (ten years later) it’s R1.8m, and a rental house for R900k that is worth around R1.8m today (6 years I think) too. I used put it down to luck at buying before the booms, but when it happens three times you have to wonder. That said, I’d love either of you to tell me where the next area to buy to double value in four years will be!

    Amazing returns by the way, you must really be smiling. I read a report that a lot of the growth in the cape is due to all the semigrants from Gauteng, and foreign buyers too. I’d move there myself if it wasn’t for the mostly enjoyable job I have in JHB.

  • Thanks Brian, again it’s one of those things I wish I’d researched earlier, I’d be worth far more if I did!

  • This was very enlightening. But it begs the question (and you may have answered it elsewhere but i missed it), do you not invest in an RA wrapper? You had an article about how that’s the ultimate way to say wassup to the taxwoman, but the more I read about your allocation philosophy the less it ties in with that. You’d need significantly more SA equity exposure to be Reg 28 compliant. So what’s the story, ditching the RA tax break in search of higher returns and global diversification?

  • That’s very well spotted mylky. I don’t have an RA purely because I work for the UN and therefore don’t pay South African taxes. For everyone else I still recommend one.

    The maximum CGT is 16.4%, so if you pay a higher percentage tax than that it’s with having an RA. Try keep the costs low, I think the sygnia skeleton 70 balanced fund is the best in SA. My wife has hers there and puts the maximum 27.5% away.

  • Aaaah that makes sense! Thank you for clarifying.

    Incidentally, my RA is with Sygnia (skeleton balanced 70, just like your wife’s) and I just lump-summed enough to catch up for the months where I was paying off my student debt, so by Jan I should be close enough to the 27.5% max. I qualify for GEPF but since I don’t plan on working for govt for long enough for the match to make a dent, I’ve opted out and decided to take retirement savings into my own hands. (If I’m still working in govt hospitals in 10 years, this may be a mistake, but I should be financially independent by then so no biggie.)

    Thanks so much for your site/forum/etc.

  • Hmmm…but now I’m a little confused. Does this math only apply if I convert my rands to dollars (or whatever other low inflation currency) and *then* invest in international index funds? Would it not apply if I bought international index funds with rands via the JSE? Am I still “screwed” because my funds are denominated in rands despite not being invested locally? o.O This is the kind of stuff that really causes inertia for me, esp about where/how to invest non-RA, non-TFSA discretionary savings…

  • Let’s compare if you buy VWRD in dollars or it’s closest equivalent DBXWD in Rand. Now imagine we have zero growth for 10 years. Due to inflation your DBXWD would “appear” to be worth 79% more, and you’ll have to pay tax on that “gain”. If you’d invested in VWRD, your investment would only appear to be worth 22% more, so you’ll still have to pay tax (if you’re over the R40k threshold) but the amount of tax will be significantly lower.

  • Thank you for the example. That makes sense. Something I’ll have to consider as the money I have available to invest grows, hopefully I’ll learn and gain confidence in offshore investments within the next year or so and take the plunge!

  • MoneyChief

    Good article and should certainly lower tax bills based on past numbers. The only thing I am concerned about is this: I open an account in USD and invest in the world. Then at some point I see that the current amount multiplied by 4% (in USD converted to Rand) is enough to live on. So I quit my job. Then all of a sudden the Rand strengthens (unlikely but possible) against the USD and I no longer have enough to live on.

  • Arno Kotze

    Hi Patrick, to add to Mylky’s commentquestion. My wife’s company does not have a retirement fund policy, so we have carte blanche on how we want to save a percentage of her income (whereas I have to contribute to my company’s retirement fund). Now my first thought would have been to get an RA, but after reading your articles, I am not sure anymore. Is it not better to invest the first R2.5k per month in a TFSA (buying ETFs) and only then getting an RA (consisting of UTs), rather than spending as much as we can on an RA and not having any money left to put in a TFSA. I hope the question makes sense, but in comes down to the order because we might not be able to afford to contribute 15% to an RA and then another R2.5k pm in an TFSA.
    Thanks

  • Raymond BC

    Bokkeman, the same can be said of just about any investment that is extremely concentrated. For example imagine taking 3 million rand and dumping it on one share on the JSE, imagine Kumba. So you can also get 2.5x growth over a few years. However the risk of concentration should be retionalised when compared to the returns. When you bet on property like that you are betting on an extremely concentrated investment and often with leverage, which exacerbates movements up and down. This article is not about property investing.

  • Raymond BC

    Bokkeman, the same can be said of just about any investment that is extremely concentrated. For example imagine taking 3 million rand and dumping it on one share on the JSE, imagine Kumba. So you can also get 2.5x growth over a few years. However the risk of concentration should be retionalised when compared to the returns. When you bet on property like that you are betting on an extremely concentrated investment and often with leverage, which exacerbates movements up and down. With property, are you really getting compensated appropriately for the concentration risk. Really imagine how far you could outperform the 2.5x you refer to by taking a punt on one company. Could you ever bring yourself to do that, or would your natural sense of self preservation kick in? But with property we are much more comfortable with punts like this? This article is not about property investing.

  • Lupa

    It seems I’m in a similar situation to Mylky – don’t really even have a clue how to begin with offshore, other than using my bank’s platform which has high platform fees, only actively managed funds with high TERs and high initial investment limits. Any pointers on where to go for info on this? Platforms to look at?

  • Hi Lupa, I use interactive brokers. They are the cheapest for me because I have a USD account and over $100k so the account fees are waived. Under $100 you need to spend $10 a month with them. That could be in fees or commission, but if you don’t get to $10 you need to pay in the difference. An even cheaper option would be to find a way to get a euro bank account, then open a CUSTODY (very important) account with De Giro, and buy the euro equivalent of VWRD with zero transaction fees.

  • In general if you’re in the higher tax brackets you’ll find RAs save you more than TFSAs, but for lower earners TFSAs seem to win. I’m leaning more towards maxing out your TFSA though, as you can always catch up your RA if you become a much bigger earner in future, but you can’t catch up a TFSA.

    More benefits of the TFSA over the RA is you won’t be taxed in future on a TFSA, no scary surprises should we ever get completely scary taxes. You can also get your money out (though don’t as you can’t put it back in) should there be some extremely pressing reason. The only viable reason I could think of would be a Zimbabwe situation.

  • Arno Kotze

    Thanks Patrick, that makes sense. Appreciate the feedback.