By Mags Heystek*
Many investors tend to use a universal benchmark when gauging investment performance, and most default to Money Market rates, and to a lesser extent, cash rates that their banks provide in current accounts. There are many different money market fund options available, and the performance is roughly equal, because the underlying investment universe is relatively constrained.
In a world where the actual use of physical cash is declining, Money Market is still as popular as ever. But do money market funds have a place in modern investing, and should investors be using it in the long term?
Based on the chart below, a Money Market investment with Ninety One would have given investors an annualized return of 7.14% over the last 10 years.
The ZAR returns on Money Market has been pretty straightforward. Investors have had consistent returns over the last ten, five, and three 3 years. It seems that having invested in a money market fund has been a good investment. But let us dive a bit deeper into the other factors that investors tend to overlook.
Let’s assume an investor started with R1m in a money market fund at the beginning of 2016 and has remained invested for 10 years.
At an annual return of 7.14%, the value after 10 years would be worth R1,992,100*
Sounds great, right? Yes, but in reality, a different picture emerges.
It’s kind of like when car manufactures claim impressive mileage on new models, when the car is in a controlled environment, drives at a constant speed, and the outcome is quoted in the best world, best case scenario. Unfortunately, this is never the case.
To quote Benjamin Franklin:
“In this world, nothing can be said to be certain, except death and taxes”
And taxes there will be.
Before we proceed to the next table, let us just make the following assumptions:
The investor is below 65 years old at end of investment term
Initial investment: R1,000,000
Final gross value: R1,992,100*
Gross annualised return: 7.1349%
Annual Interest exemption: R23,800
Marginal tax rate: assuming a 45% income tax rate (the highest currently)
Fully taxable money market interest
Tax paid annually
* Inflation adjusted using official South African CPI figures
When committing to a Money Market fund, Investors tend to overlook two things. Inflation, and the net growth (after tax). In the previous table, we know that the value after 10 years of R1m, would be worth R1,992,000 ten years later, there is no doubting this, but if we look at the net return (after tax and exemptions have been taken account), money market has effectively provided this investor with 4.78% return per annum. Assuming the average inflation rate over the last 10 years was roughly 4.61%, the real return from money market is actually closer to 0.18% per annum.
Has this investment grown? Yes, technically, but this is before tax and inflation.
Has this investor made real capital growth? Not really.
For reference, the real annualized return at different income tax brackets.
Money Market should be used for short term cash savings. Investors are “saving themselves poor” when making use of Money Market. Nominal returns in money market funds can look attractive, but after inflation and tax, real wealth creation is often negligible over long periods
When deciding on an investment strategy, regardless of age, there are alternatives to use, and investors need to be comfortable with increasing and adjusting their risk profiles. Investors have the ability to blend their portfolios with cash, bonds, and equity, but purely relying on money market for long term capital growth is just not effective.
* Mags Heystek, CFP®, is a financial advisor at Brenthurst Wealth and is based in Cape Town. mags@brenthurstwealth.co.za