Best way to invest a lump sum of money in South Africa

Lump sums of money have been known to make people either panic or overspend. Several studies done have shown that 5 to 10 years after winning the lottery, a vast majority say they find themselves in a far worse financial position then they were in before winning.

Many South Africans may be familiar with the television show “I Blew It” which showcases individuals who have won large sums of money and are now left with nothing.

Lump sums of money can offer relief but also cause anxiety, you may ask yourself what do I do next?

This article helps provide insight on the best way to invest a lump sum of money in South Africa.

What is a lump sum amount?

A lump sum is a single payment of a sum of money. Lump sums are generally used for retirement plans, inheritances and even lottery pay-outs.

8 Things to consider before making an investment decision

1. Draw a personal financial roadmap. 

Before you make any investing decision, sit down and take an honest look at your entire financial situation especially if you’ve never made a financial plan before.

The first step to successful investing is figuring out your goals and risk tolerance – either on your own or with the help of a financial professional.

2. Evaluate your comfort zone in taking on risk.

All investments involve some degree of risk. If you intend to purchase securities - such as stocks, bonds, or mutual funds - it's important that you understand before you invest that you could lose some or all of your money. The reward for taking on risk is the potential for a greater investment return.

3. Consider an appropriate mix of investments.

By including asset categories with investment returns that move up and down under different market conditions within a portfolio, an investor can help protect against significant losses. Historically, the returns of the three major asset categories – stocks, bonds, and cash – have not moved up and down at the same time.

4. Be careful if investing heavily in shares of employer’s stock or any individual stock.

One of the most important ways to lessen the risks of investing is to diversify your investments, don't put all your eggs in one basket.

5. Create and maintain an emergency fund.

Most investors put enough money in a savings product to cover an emergency, like sudden unemployment. Some make sure they have up to six months of their income in savings so that they know it will absolutely be there for them when they need it.

6. Pay off high interest credit card debt.

There is no investment strategy anywhere that pays off as well as, or with less risk than, merely paying off all high interest debt you may have. If you owe money on high interest credit cards, the wisest thing you can do under any market conditions is to pay off the balance in full as quickly as possible.

7. Take advantage of “free money” from employer.

In many employer-sponsored retirement plans, the employer will match some or all of your contributions. If your employer offers a retirement plan and you do not contribute enough to get your employer’s maximum match, you are passing up “free money” for your retirement savings.

8. Consider rebalancing portfolio occasionally.

Rebalancing is bringing your portfolio back to your original asset allocation mix. By rebalancing, you'll ensure that your portfolio does not overemphasize one or more asset categories, and you'll return your portfolio to a comfortable level of risk.

Know the difference between Saving v.s. Investing

The words “saving” and “investing” are sometimes used interchangeably but they are not the same. 

What Is an Investment Objective?

An investment objective is the role that an investment, or several investments, play to help you reach your financial goals. Define your investment objectives.

Before you begin to build a portfolio, start by asking a few questions:

Short-term vs longer-term investment goals

Short-term investments are ones held for less than a year, while long-term investments are held for more than a year.

Short-term investments can be useful in a portfolio, but they do carry a heavy risk. The major benefit of a short-term strategy is that if it is handled correctly, it can bring in serious returns quickly. This money can be reinvested and continue to grow, boosting the total value of your portfolio.

With long-term investing there is a lot less risk than with short-term investments. If you’re planning on holding an investment for 20 years, it doesn’t really matter if there is a recession in year seven – as long as the overarching economic system holds up, history shows that you will be up in the long run. The con of long-term investing is that with lower risk generally comes lower reward.

Know your risk appetite

Risk is about tolerating the potential for losses. Understanding your risk appetite allows you to make well-informed decisions about your money.

Set return on investment goals

Setting investment goals is a critical step in building a focused financial plan.

1. Identify Your Goal. The first step toward achieving your goals is to identify what exactly you want to achieve.

2. Identify Your Investment Strategy. When deciding how you’ll invest the savings for your goal, be sure to consider your time horizon.

3. Start Small. Start small and get a better understanding of the process.

4. Look for Support. Finding the advice and support you need to reach your financial goals has never been easier, information is everywhere.

Options available for your short-term lump sum investment in SA

When it comes to short term investments in South Africa there are several options, and these are our top 5.

1. Money market account. Suitable if you only want to invest for a year and you need high level of stability.

2. High yield savings account. Your deposit will accumulate interest, they typically pay 20 to 25 percent more than a typical savings account.

3. Money market mutual funds. A company uses the money that you put in and invests in short term securities like stocks, bonds, and short-term debt.

4. Tax free savings account. Gives you the allowance to have your money grow without paying the tax on growth for your investment, interest, or dividends.

5. Short-term corporate bond funds. Not insured by government but they are considered safe, and interest gets paid on a regular basis in most cases monthly.

What Is a Mutual Fund?

A mutual fund is a financial vehicle that pools assets from shareholders to invest in securities like stocks, bonds, money market instruments, and other assets.

What Is an Exchange-Traded Fund (ETF)?

An exchange-traded fund (ETF) is a type of pooled investment security that operates much like a mutual fund. Typically, ETFs will track a particular index, sector, commodity, or other assets, but unlike mutual funds, ETFs can be purchased or sold on a stock exchange the same way that a regular stock can. 

Government of South Africa Treasury Bills

Treasury bills are issued when the government needs money for a short period. These bills are issued only by the central government, and the interest on them is determined by market forces. These are short-term debt instruments denominated in South African Rands (ZAR).

Money Market Fund?

A money market fund is a kind of mutual fund that invests in highly liquid, near-term instruments. These instruments include cash, cash equivalent securities, and high-credit-rating, debt-based securities with a short-term maturity.

RSA Retail Savings Bonds

The RSA retail savings bonds are great, but they have their place and time. For one these are bonds and pay interest, they have no volatility. They will go up every quarter when interest is paid, and don't go down.

Fixed Annuities

A fixed annuity is a type of insurance contract that promises to pay the buyer a specific, guaranteed interest rate on their contributions to the account. 

Dividend-Paying Stocks

Dividend stocks distribute a portion of the company's earnings to investors on a regular basis. Most dividend stocks pay investors a set amount each quarter, and the top ones increase their pay-outs over time, so investors can build an annuity-like cash stream.

Should you invest a lump sum or regular?

If you’re investing a lump sum, you should follow some basic good practice – such as ensuring diversification and ensuring they have a balanced portfolio. This helps when the markets are volatile. 

More conventional short- and long-term investments for your lump sum

Paying extra on your bond

Ultimately, the biggest benefit of settling your home loan faster is that over the loan term you will save on interest costs. 

Paying extra on your credit card

If you don't have a lot of extra money to throw at your credit cards as part of your debt payoff efforts, the great news is that even small amounts added to your payments can make a big difference over time.

Opt for tax-free savings

Saving in a tax-free savings account gives you flexibility as you don’t have to commit to any future contributions. National Treasury has put limits on the amount you can save in a tax-free savings account. The total annual contribution in a tax year may not exceed the annual contribution limit, which is currently R36 000 per tax year. The total lifetime contribution may not exceed R500 000.

Invest it in a unit trust

A unit trust is an unincorporated mutual fund structure that allows funds to hold assets and provide profits that go straight to individual unit owners instead of reinvesting them back into the fund. Unit trusts require a long-term investing, and your returns are linked to how well your investments perform.

Education fund

Investing in your children’s education is important. It’s never too early to start saving towards education, the more time you have to invest your money the more time it has to grow.

Emergency Savings

Having money put away for an emergency is critical. The COVID-19 pandemic taught us that your financial situation could change very quickly. When it comes to savings accounts what’s important is that the interest or rate of return offered by your chosen account at least matches inflation to ensure that your savings hold their value.

Conclusion

Investing large sums of money in South Africa is not always easy because of the number of options available. Remember that there are short term investments with high returns in South Africa and there are also long-term investments with high returns. Choose the option that best aligns with the financial future you have envisioned for yourself.