NFB’s very own advice column answers your questions regarding investments, personal finance, life and/or risk cover.

Q: When taking out life cover and disability cover there seems to be a myriad of options and different benefits and premiums. This is all rather confusing and I would like to know what one should be looking out for when considering taking out cover?

A: Most South Africans are under insured when it comes to life and disability cover. It is often seen as a grudge payment or one of those necessary evils. There is no benefit paid back to you and if there is then something bad has happened to you in order for the benefits to be paid.

It is therefore important for you to make sure that you are getting value for your money and understand what options you have. One needs to understand what you are getting for the premium you are paying and how that premium will change. Cheaper is not always better.

The benefits you take out will determine the price you pay. Life cover is generally the same across all companies. It is in the disability and severe illness space that you may find differences in how these benefits are paid. You have the choice of Comprehensive cover or Core cover. We would always suggest that you go for Comprehensive cover as this eliminates any gaps in your cover. You will also have the option of choosing between having benefits at lower severity levels or upgrading the cover to pay out a higher amount even though the severity level is low. Companies also offer multiple payouts and claims while others will pay out 100% of the benefit as soon as any severity level is obtained. This should be discussed with your advisor and you need to ensure that in the event of a claim that you are comfortable with what will be paid to you. If you have an illness that is in a low severity level stage then you may only receive a smaller payout initially, but should the illness get worse you could end up with more payouts than had you just received a full benefit payout in the early stages.

It is also important to understand, with Disability cover, the difference between own occupation based disability versus own or similar occupation based Disability. Own occupation disability protects you against you being able to perform your nominated occupation. Own or similar will look at whether or not you could still work and earn a living doing something similar.

You are also able to choose your disability or severe illness cover as an accelerated benefit or a stand alone benefit. If it is accelerated then this will reduce your life cover amount down by the amount of the disability or severe illness claim. Stand alone costs more, but a claim will not affect the life cover amount.

The choices you make will determine the premium you pay. You can also change the type of premium pattern and cover increases. You are able to choose between a level premium or a premium that starts off cheaper, but increases each year. You will also be able to choose what percentage you would like your benefit to increase by each year. A level premium will generally work out to be cheaper in the long run, but a premium with a compulsory increase each year will be significantly cheaper in the shorter term.

It is important to get comparative quotes and to ensure that you compare “apples with apples”. Your Financial Advisor should be able to assist and explain the differences.

Q: When seeking financial advice and deciding on a financial advisor what should I be looking for and what questions should I be asking?

A: It is always important to establish credibility. After all, you are entrusting your finances to someone. I have highlighted below some of the questions one should ask.

• Do you have a licence? – An advisor should be licenced with the Financial Services Board (FSB)
• What are you qualifications? – Ideally your advisor should be a certified financial planner (CFP) which is internationally recognized. Experience also matters, however, and should your advisor have 20 years experience and strong referrals this is often worth more.
• Continuity? – What happens if the advisor leaves or is hit by the proverbial bus. It is better to deal with a company and not an individual. Although there is an individual relationship you need to ensure that your financial planning does not fall apart if that relationship ends.
• Word of Mouth? Establish that the advisor has a good reputation. If it is a referral, find out why the client is happy. Is it due to his money doubling in a month or is it more due to the fact that the advisor has set a long term plan in place that works and the client has seen the benefits of building a legacy. Does the advisor give regular feedback?
• What services can you offer? Your advisor should be able to provide you with retirement, investment and estate planning. While it isn’t necessary that your advisor is an expert in all these areas (in fact be wary if he says he is), he must have alliances with other firms that can provide you with expert advice. The role of the advisor is to bring it all together for the client and manage the relationship.
• Who are your providers? Make sure your advisor has contracts with reputable firms. Your advisor should have a deep understanding of the products he is offering and a good relationship with that company to ensure quality service.
• Is your advisor market related? You should establish what market research he has access to. Is he basing the decision on his own gut feel or does he have a process and management team that assist with market and economic decisions.
• How often will we meet? It is important to establish when your portfolio will be reviewed. It should be a minimum of once a year. During this meeting your advisor should assess your plan against the actual outcome and adjust the plan accordingly.
We believe that at NFB we meet the above criteria.

Q: There was the Bernie Madoff scheme in the US and now recently the Tannenbaum scam in SA. What does one need to look out for to avoid these types of investment schemes or scams?

A: Despite tight regulations, there will always be scams looking for culprits, it is very important that investors assess counterparty risk before an investment is made. It amazes me how supposed smart investors apparently put in millions without a hint of due diligence.

Below are some of the points to look out for when investing.

• Understand clearly the investment strategy – “Some investment opportunities appear alluring simply because they are described in impressive, complicated terms. Investment strategies and financial products should be clear and understandable. If you don’t understand it, stay away.
• Match investment strategy to reported performance – One of the red flags in the Madoff affair is that reported performance was too consistently good.
• Watch out for e-mail solicitations and Internet fraud – The internet is a low-cost way for scammers to reach millions of people. Unsolicited e-mail messages offering you investment opportunities that sound too good to be true probably are.
• Be wary of “sure things,” quick returns, and special access – Legitimate investment professionals do not promise sure bets. Legitimate get-rich-quick schemes simply do not exist. Also, understand clearly the terms by which you can redeem shares or exit the investment. When can it be done and what are the fees? Ponzi schemes become unsustainable when investors pull out their money.
• Understand what, if any, regulatory oversight exists – Fraud will be less prevalent in well regulated settings, like unit trust funds.
• Assess the operational risk and infrastructure – Any investment management operation should have a physical infrastructure for trading and administration. Ask to see them and inquire about the firm’s processes and controls. It is important that a firm have separate, independent operations for asset management, trading, and custody to provide checks and balances against fraud.
• Ask about independent audits and who performs them. An auditor should be independent, reputable, and congruent with the size and scope of the investment operation.
• Assess the personnel – Ultimately, the reliability of any operation is predicated on the integrity and competence of its people.
• Perform a background check. If an advisor firm or investment manager is not listed with the FSB (www.fsb.co.za), find out why. If they are, make sure their record is clear.
• Limit your exposure – One of the surest ways to avoid the catastrophe associated with investment fraud is to limit the amount you invest. Diversification is one of the most fundamental and enduring investment principles.

Q: What is the ideal income percentage one should draw from your Living Annuity in order for one’s income and capital to keep up with inflation?

A: The simple answer would be to say, “the less you draw the better”, but clearly the income that you take needs to meet your budgetary requirements. If we were to assume that inflation plus 4% is a sustainable return on your capital invested it would give you an overall return of around 11% assuming an inflation rate at 7%. In order for your income to therefore keep up with inflation and maintain the buying power of your capital, we would suggest that your income withdrawal be between 4% and 6.5%. Current legislation allows for the investor to draw between 2.5% and 17.5% on their living annuities. By drawing a percentage that is lower than the actual growth in the portfolio it allows the excess growth to capitalise in the portfolio, thereby ensuring that there is income and capital growth over time.

Your tax status also needs to be taken into account and you may be able to draw less as your tax rates generally improve in your retirement years.

It is important to also look at the risk levels within your portfolio, as this will determine the returns you can expect as well as the levels of volatility. Make sure the portfolio matches your risk profile and that it is managed by a professional. It would also be wise to review the portfolio and income levels on an annual basis to ensure that you are keeping ahead of inflation.

Q: In order to outperform inflation, is it best to try and invest in one particular asset class at any given time or to diversify?

A: It is always important to establish credibility. After all, you are entrusting your finances to someone. I have highlighted below some of the questions one should ask.

• Do you have a licence? – An advisor should be licenced with the Financial Services Board (FSB)
• What are you qualifications? – Ideally your advisor should be a certified financial planner (CFP) which is internationally recognized. Experience also matters, however, and should your advisor have 20 years experience and strong referrals this is often worth more.
• Continuity? – What happens if the advisor leaves or is hit by the proverbial bus. It is better to deal with a company and not an individual. Although there is an individual relationship you need to ensure that your financial planning does not fall apart if that relationship ends.
• Word of Mouth? Establish that the advisor has a good reputation. If it is a referral, find out why the client is happy. Is it due to his money doubling in a month or is it more due to the fact that the advisor has set a long term plan in place that works and the client has seen the benefits of building a legacy. Does the advisor give regular feedback?
• What services can you offer? Your advisor should be able to provide you with retirement, investment and estate planning. While it isn’t necessary that your advisor is an expert in all these areas (in fact be wary if he says he is), he must have alliances with other firms that can provide you with expert advice. The role of the advisor is to bring it all together for the client and manage the relationship.
• Who are your providers? Make sure your advisor has contracts with reputable firms. Your advisor should have a deep understanding of the products he is offering and a good relationship with that company to ensure quality service.
• Is your advisor market related? You should establish what market research he has access to. Is he basing the decision on his own gut feel or does he have a process and management team that assist with market and economic decisions.
• How often will we meet? It is important to establish when your portfolio will be reviewed. It should be a minimum of once a year. During this meeting your advisor should assess your plan against the actual outcome and adjust the plan accordingly.
We believe that at NFB we meet the above criteria.

Q: My wife and I both lead healthy lives and feel that the premiums we pay on our life and disability policies could be put to better use elsewhere. Are we putting ourselves and the family at risk by moving these premiums into an investment?

A:There are some risks you can’t afford to take. Everyone needs assurance against death and disability. It is something everyone, except the very wealthy, needs.

The importance of having life assurance – also known as risk assurance – is underscored by asking yourself two simple questions:

• What will happen to me (and my dependants) if I am sick and/or disabled and no longer able to earn a living?
• What will happen to my dependants when I die?

Not being paid a benefit does not mean you have paid premiums fruitlessly. It means you have enjoyed many years of peace of mind knowing that both you and your family would not have been left destitute if the unexpected had occurred. Although you can invest money on a monthly basis, it takes years to build up to an amount that will cover your needs. Over this time you are taking risk as you are betting on nothing happening to you.

Deciding whether or not to take out life assurance has nothing to do with taking a betting chance that you will die at age 100 in your bed. It is about ensuring that you and your dependants will never be put at risk should you be hit by the proverbial bus.

At different stages of your life you will need different risk assurance products and different benefits. You constantly need to revise what and how much risk assurance you require, particularly when your circumstances change. Marriage, a birth, a death, divorce or a pay increase can all alter how much life assurance you need.

Your guiding principle should be to aim to ensure that both you and your dependants can maintain a certain standard of living, no more and no less. Risk assurance is not there to make anyone wealthy. If you spend too much on risk assurance, you will be denying yourself money that could be spent on other things that you require now.

Among other things, you can protect your savings plans, standard of living and business interests.

Taking a guess is not good enough. Ask your financial adviser to help you work out your risk assurance needs. You need to take out assurance that suits the requirements of the different stages of your life, your personal circumstances and the general economic environment. It is also not only a matter of how much life assurance you need, but also how much you can afford.

Q: I want to start investing on a monthly basis, but the interest or growth that one receives seems so insignificant as the monthly amounts are not large. Is it still worth my while to do so?

A: It may not seem like much, but you have to start somewhere and the sooner you start, the better the compounding effect on capital growth in the long run. After 10 years, the interest will be twice as much as what you are saving. In year 15, the interest is nearly five times as much as you are saving. At the end of 40 years, your investment could be generating more in interest than you are earning from your job.

It’s important to remember that compound interest/growth takes a while to gather steam. In the beginning, if you are saving a small amount it may seem that the interest you earn is insignificant, but as the amount grows it earns more interest and more interest on interest. In the end your money will be working harder than you.

Q: What steps should I be taking in planning my retirement investments?

A: Below are a few basic staps

• Settle all short term (credit card) and long term (home loan) debt and capital requirements, such as the purchase of a vehicle.
• Establish the existing sources of capital and income. This would be from retirement funds, retirement annuities and discretionary monies already accumulated.
• Calculate the optimal (most tax efficient) manner of taking your lump-sum benefits from any retirement funds you are leaving. Also consider the most tax efficient manner of investing your after-tax and discretionary funds. This would include income tax, estate duty and capital-gains tax (CGT) consequences.
• Establish your appetite for risk. Factors to consider would be longevity, inflationand market risk. These three areas are the biggest contributors to not achieving your long-term income and capital needs. The three risk factors require balance to achieve your long-term income and capital requirements.
• Consider your different product options, which would be different for your retirement assets and your discretionary monies. This would include annuity choices — fixed, flexible, or a combination. Tax efficiency of the vehicles — income tax, CGT and estate planning implications, guarantees and portfolio construction.
• Asset allocation is the building block of your investment growth for both retirement and discretionary assets. Asset classes such as equity, bonds, cash and hedge funds all have diverse risk- and-return benchmarks and strategies. The blending of these to meet your individual needs is a process which may require diversification of several classes and managers.
• Advisory fees, administration costs and asset manager fees/portfolio fees, including possible performance-based fees. These should be taken into consideration both for implementation of the investments and then the ongoing management of the investments.
• Ongoing reporting, servicing and administration. Establish and understand the service mandate for your investments, including the role of your financial adviser, the product supplier and portfolio managers.

If you have not found an answer to your question, you have the opportunity to write to our professional and experienced financial advisors for advice and we will answer any questions that you may have. Please complete our enquiry form here