The impact of inflation on TFSA returns – and how to protect your growth

The tax-free savings account isn’t actually a savings account. It’s an investment product which was implemented in South Africa in March 2015. The idea behind this kind of investment is to incentivise South Africans to save, as South Africa has a low national savings rate. With a TFSA (tax-free savings account), you can invest money without the need to pay any tax on returns. You pay no tax on income, dividends, capital gains, and most importantly, withdrawals. 

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As an investor who is making use of a TFSA to save money, you also need to take into consideration the effects of inflation on your capital and real returns. This article will delve further into the effects of inflation on your TFSA and ways in which you can potentially try to mitigate these effects by examining both the fees you are paying and the asset allocation of your TFSA. 

What is a tax-free savings account?  

The National Treasury introduced the TFSA in South Africa as a way to encourage South Africans to save more money. The TFSA is viewed as a long-term investment vehicle with the idea of leaving the money invested and avoiding withdrawals as far as possible. With TFSAs, there are certain limits to the amount of money that you can contribute. These limits are R36,000 per annum (R3,000 per month) and R500,000 over a lifetime.  

It’s important that you don’t contribute over these limits, as this will result in a tax penalty of 40% to be imposed on any excess contributions. All dividends received and interest earned are not taxed, which may then allow for more of the contributions to be reinvested and potentially grow over the long term. You can withdraw money at any time, without being taxed.  

The TFSA should be viewed as a long-term investment, so you should generally avoid withdrawals, unless in the case of an emergency, to get the most out of your investment. This allows you to take advantage of the potential long-term, tax-free growth offered by the TFSA. To potentially maximise your TFSA savings, it’s important to understand the threat of inflation and how to protect your growth.  

The threat of inflation on savings and investments 

Inflation has the impact of reducing the purchasing power of our money. We can see the effects of inflation when we visit the grocery store and notice how the grocery prices have increased from one month to the next. Inflation reduces the purchasing power of your money, meaning you can buy less with the same amount over time. For your investment to grow, you need to ensure that it is outperforming inflation. This means that when you evaluate the returns on your investment, be sure to look at the real returns and not just the nominal returns.  

The real returns are the nominal returns that have been adjusted for inflation. If your TFSA has generated, for example, a return of 12% and inflation is 6%, then your real return is 6%. If your TFSA is generating lower than inflation returns, then the value of your capital is essentially decreasing over time, once the effects of inflation have been taken into account. This effect may be further exacerbated in times of higher inflation and market volatility.  

The importance of asset allocation in beating inflation  

As an investor with 10X, you have the freedom to customise your investment portfolio by choosing from a selection of expertly curated investment funds. These funds allow you to diversify across different asset classes such as equities, properties, bonds and even offshore investments. When structuring your portfolio and choosing your investment funds, consider your time horizon and investor goals, as different funds have different aims.  

If you are more of an aggressive investor with a high risk tolerance and a long time horizon, you may wish to include a higher percentage of equities in your portfolio. On the other hand, if you are a more conservative investor, you may prefer to include more bonds in your portfolio to add more stability.  

Equities are the most volatile of the asset classes, but have the potential to produce the best returns in the long term. Bonds are more stable, but you may receive lower returns on these. Property may result in better returns when compared to bonds in some market conditions, and cash is the most stable of the asset classes, but it may produce the lowest returns.  

Historically, equities have shown to outperform inflation in the long term (based on JSE All Share Index performance versus CPI from 1960-2020). Of course, past performance does not guarantee future results. TFSAs lend themselves well to long-term investing, as more of the potential returns can be invested, given that these are not taxed, thereby allowing the reinvested returns to potentially compound and grow over time. 

You may also wish to include some offshore exposure in your underlying portfolio. This can potentially add some protection against local market volatility and the depreciation of the Rand, as well as allow you to potentially gain from any positive market returns in the offshore market. With 10X, you can invest your TFSA 100% offshore, if you wish.  

10X allows you to select from a range of funds within the TFSA wrapper, each with a different mix of asset classes, allowing you to diversify your asset allocation and meet your financial needs as you move through the different stages of your life. By diversifying your asset allocation, you can potentially take advantage of market gains in certain asset classes while also protecting yourself to some extent from potential losses in other asset classes. 10X takes a long-term view when looking at investing, aiming for growth while also adding some protection against inflation. A few of the available 10X funds include:  

10X Your Future Fund (Flagship): The 10X Your Future Fund is a multi-asset fund suited to investors looking at long-term capital growth achieved through cost-effective exposure to different local and international asset classes.  

10X Income Fund (Flagship): The 10X Income Fund is carefully designed to provide investors with a high level of income and long-term capital stability via cost-effective exposure to different local and international-bearing assets. Returns may fluctuate in the short term, so the fund is best suited for investors with a time horizon of longer than three years.  

10X MSCI World Index Feeder Fund (Offshore): The 10X MSCI World Index Feeder Fund gives investors comprehensive offshore exposure by tracking the MSCI World Index, capturing the performance of large and mid-cap equity securities spread across 23 developed market countries. The fund aims to closely match the index’s performance in ZAR by investing in the dollar-based iShares Developed World Index Fund (UCITS), potentially maximising long-term capital growth through a diversified global equity portfolio.  

10X Moderate Fund: The 10X Moderate Fund is great for investors seeking capital growth with a lower level of volatility when compared to a high-equity portfolio over the medium to long term. The portfolio includes exposure to a range of local and international asset classes, with a higher allocation to growth assets than to defensive assets. The most suitable time horizon is longer than three years, as returns may be volatile in the short term.  

We understand the importance of asset allocation in the potential overall growth of your TFSA. To find out more about 10X’s fund offering, follow this link. 

Investment fees – the silent killer of real returns  

High fees can affect your real returns, especially when compounded over the long term. Lower fees would instead allow more of our potential returns to be reinvested, and then these would have the opportunity to potentially compound and grow over the long term.  

Let’s look at an example of 1% in fees versus 3% in fees with an inflation rate of 6% to illustrate the effects of lower fees (1%) versus higher fees (3%) and the importance of trying to minimise the fees you are paying. If you invest R100,000 with the fund returning 12%, your investment value is now R112,000.    

Scenario 1: Let’s imagine that the fees being charged on the investment are 1%, you will need to pay R1120 in fees. Your return is R10,880, so your net value before inflation is R110,880. After adjusting for inflation, the value is R104,600. Your real return after adjusting for inflation is R4,600.   

Scenario 2: If you then amend the fees on the investment to 3%, you will need to pay R3,360 in fees. Your return is R8,640, so your net value before inflation is R108,640. After adjusting for inflation, the value is R102,500. Your real return after adjusting for inflation is R2,500.   

There is a clear difference between 1% in fees and 3% in fees. With lower fees, your chances of outpacing inflation are higher.   

If we take the same example and apply it over 30 years, we can see the compounding effect of low vs higher fees. The examples of 1% and 3% fees when compounded over the long term are as follows:   

• Scenario 1 (1% Fees): Real investment value is approximately R398,500, after 30 years. 
• Scenario 2 (3% Fees): Real investment value is approximately R231,000, after 30 years. 

 The effect is even more pronounced over 40 years:  

• Scenario 1 (1% Fees): Real investment value is approximately R631,900 after 40 years. 
• Scenario 2 (3% Fees): Real investment value is approximately R305,300 after 40 years.  

We can see how low fees can give you more breathing room in terms of outpacing inflation. Note that the above example is for illustrative purposes only, and actual results may vary.  

The Effective Annual Cost (EAC) is a metric which was introduced to enable you to see what you are paying in fees and costs over a one-year period. This includes any fees that you may see charged, such as advisor fees, administration fees and management fees, as well as any additional costs or penalties. This would then also allow investors the opportunity to compare their EAC with those of other service providers and then, using this information, be able to make an informed decision as to their choice of service provider.   

However, it’s important to remember that the EAC is just one factor to consider when evaluating investment options. All factors being equal, you can imagine that a higher EAC would allow less of your potential returns to be invested. Conversely, a lower EAC will allow for more of your potential returns to be reinvested and grow over time. Here is an EAC calculator that you can use to calculate your existing fees.   

Choosing a transparent service provider with low fees may be the key to setting you on the right track when it comes to your TFSA. Low fees allow for more of your returns to be reinvested and potentially compound and grow over the long term. 10X offers a low-fees of 1% or less for most products. You can expect no platform fees, no advisor fees and no exit fees. Please refer to our fee structure on our website to find out more or speak to our knowledgeable and experienced investment consultants.  

A summary of how to protect your TFSA against inflation   

An important goal should be to protect your TFSA against inflation. There are a few strategies that you can consider to potentially keep you on the right track.   

First, taking the long-term view when considering investing is key. This includes avoiding any emotional decisions or knee-jerk reactions to political or global events that may result in a downturn in the market.   You may also want to include growth-oriented assets, such as equities, in your underlying portfolio to try and outperform inflation, as past performance has shown that asset class has the best track record in this regard. Of course, this does not guarantee the same results in the future.   

You should also regularly review your TFSA and its asset allocation to ensure that it is still aligned with your financial goals and requirements. And finally, you may want to consider choosing low-cost providers who are transparent about fees to allow for more of your returns to be reinvested and potentially grow and compound over time. 

Conclusion: Tax-free savings accounts and inflation  

To conclude, as an investor with a TFSA, you must take into consideration the damaging effects of inflation. It has the effect of reducing the purchasing power of your money over time. To try and potentially maximise your returns and success of your TFSA, you want to carefully consider asset allocation, be aware of the fees that you are being charged and try to minimise high or unnecessary fees while keeping your funds invested as long as possible, to allow for potential growth over the long term. By regularly reviewing your TFSA, you can strive to protect potential growth and outperform inflation, whilst potentially realising your financial goals in the long term. 

Understanding how to protect your TFSA from inflation is an important part of potentially maximising its value. 10X follows a low-cost, index-tracking approach designed to help investors grow their savings over time. We follow a straightforward investment strategy based on maximising long-term returns and designed to protect your future. Grow your tax-free savings with a 10X TFSA. Just reach out for more information.