Cash investments in South Africa are offering lucrative returns in 2024, thanks to local interest rates that have soared to levels we haven’t seen since 2009. While cash is generally considered a defensive investment that shields you from the volatility of riskier asset classes, it could currently be your asset class of choice, depending on your circumstances.
Short-term cash investment options such as call accounts, money market funds, and fixed deposits are enticing because a solid 8.5% annual return, with a low risk of capital depreciation, undoubtedly instils a certain sense of security. When you compare it with the recent turbulence in equity markets in particular, the allure of a risk-free return begins to look more and more attractive. Yet despite these advantages, cash investments do come with their share of pitfalls.
What are the risks behind the “risk-free return”?
There are two main risks to consider:
- The inherent vulnerability of the South African rand (ZAR), and
- the tax implications of holding cash.
Let’s dive in and take a closer look at each of them.
The effect of rand vulnerability
When the South African rand (ZAR) weakens, the returns on your cash investments erode in US dollar terms.
South Africa’s economy is tiny, making up less than 0.7% of the global investment opportunities, and we grapple with high levels of political uncertainty, sluggish growth rates, and deteriorating national infrastructure. The spectre of an expanding budget deficit exacerbates these risks further and contributes to the rand’s continuing weakness relative to other currencies.
And although it’s not an immediate concern, the potential for a currency collapse triggered by a government debt default is increasingly plausible which could trigger hyperinflation and render local currency holdings virtually worthless: a fate already witnessed in nations like Zimbabwe, Venezuela, Argentina and Turkey.
As a result, having money in cash does come with some risk of loss.
Considering what the taxman taketh
The lure of high interest rates on cash investments is undeniable, but the tax implications take some of the shine off your results because, unlike capital gains, interest earned on cash is fully taxable at the investor’s marginal tax rate (although there are certain exemptions). What does this look like in reality? Let’s take an example:
An individual who is under the age of 65 and taxed at a marginal rate of 45%, invests R1,000,000 at an 8.5% interest rate. After factoring in tax and exemptions, the net after-tax return on that investment would be only 5.7%.
So, under what circumstances should you invest in cash in 2024?
Here are the things to consider, when deciding whether “cash is king” currently:
- If you have a short investment horizon, and
- you need capital certainty, and
- volatility is a concern…
… then cash is currently the prudent choice for you, despite its drawbacks.
In addition, its liquidity makes cash an ideal defensive component within investment portfolios, because it is readily accessible when you need it.
What is the alternative to cash investments?
If you are an investor in search of defensive assets with high marginal tax rates, exploring offshore money market funds denominated in currencies like USD, GBP and EUR could be beneficial.
These hard currencies currently offer interest rates ranging between 3.5% and 5.5%, with accumulating funds providing the added advantage of tax-efficient returns.
Capital gains tax would apply when you access your funds, at a maximum effective rate of 18%.
Fluctuations in the rand’s value would impact returns: Rand depreciation would contribute positively to your portfolio, while rand appreciation would conversely dampen your returns in rand terms.
What do we conclude, then?
Cash is undoubtedly an integral part of investment allocation but careful consideration is essential, taking into account its risks and the possible alternatives, to optimise your overall investment strategy.
As always, it boils down to the specifics of your individual needs and current situation. Speak to your CERTIFIED FINANCIAL PLANNER® professional to help you make an informed and objective decision.
By Michael Maré, CFP® FPSA®
B.Com