On the money: Let tax-free savers profit from stocks

tax saving 1Author: Stuart Theobald (BDlive)

The Treasury is busy missing an ideal opportunity to encourage individuals to invest directly in shares listed on the stock market.

It apparently thinks that this would be a bad thing. It is wrong. South Africans are useless at saving. Only 42% of adults have any savings at all, the rest preferring to spend as they get it or borrow to consume. We have become addicted to consumption. Over 60% of our gross domestic product is made up of final consumption expenditure.

This is not a good thing. Consumption is not a very productive form of spending. We would be better off if we saved our money so that it was spent on investment instead. That would drive economic growth because investment generates greater value added than consumption. It also tends to employ more people because investment goes into companies which hire people to generate returns, while consumption is the end of the value-adding line.

Our lack of savings also means we rely on foreign capital flows to finance investment, making us vulnerable to international economic shocks.

The Treasury wants to change that by introducing tax-free savings accounts. The proposal is that individuals save up to R30,000 a year in an account that will be totally free of tax on the interest, dividends or capital gains from those savings. The initial plan is to cap savings at R500,000 of lifetime contribution, but it would take almost 17 years to get to that cap as it is.

The special tax-free accounts can be offered by any current investment provider, from your bank and insurance company to your stockbroker. The accounts can hold either interest-bearing or equity-type investments, but the policy explicitly prohibits holding individual shares.

Collective investment schemes and exchange-traded funds are fine, though.

The prohibition on individual shares is unfortunate. The Treasury is fearful that if individuals are allowed to invest in shares without capital gains tax they will do so in risky penny stocks, rather than proper blue-chip companies. It apparently thinks that behavioural economics supports this view.

We know investors can be pretty silly when it comes to share investing as they can trade too often, buy inappropriately risky stocks, and sell out of panic rather than sober assessments of risks. This is all true of some investors, but certainly not of all investors.

Research by my company, Intellidex, shows 75% of retail investors make fewer than three trades a month, with larger portfolios making the fewest, which hardly reveals speculative motives. The Treasury is ignoring that there are downsides to concentrating equity investment in the hands of professional investors.

Over the past 50 years, the proportion of equity market capitalisation held by private individuals has fallen dramatically.

According to one study, in 1960, only 15% of US stocks were held by institutions rather than individuals but by 2007 this had risen to 68%. Institutional investors are not, contra the Treasury, particularly wise.

Professional investors are often more worried about job security than investment returns, so there is an incentive towards herding behaviour, driving bubbles. It’s pretty hard to get fired for being just as wrong as everyone else. They also tend to stay in investments that they know are going to underperform, because their mandates force them to and their incentives encourage them to signal that their particular portfolios are good ones to be in.

In short, the major bias in favour of professional investors over private investors causes its own set of problems for market efficiency. The Treasury knows full well it is bad if banks are overreliant on institutional funds rather than retail deposits, but apparently stops short of applying that same logic to capital markets. I guess that our institutional investors are pretty effective lobbyists, while the private investor has no voice.

There is another reason to encourage private investors to invest directly in the shares of companies: it gives them a direct incentive to support the performance of those companies.

Would our platinum miners still be on strike if mineworkers held shares in those companies? Would we so easily tolerate poor industrial policy if we could see the effect on share prices in our own portfolios?

Individual share ownership in tax accounts could also be used to support black empowerment schemes. They could provide an ideal vehicle for individuals to hold their shares in the empowerment schemes of Sasol, MTN and others.

The Treasury is still developing its thinking and will only start moving towards formally introducing the scheme next year. So there is still time to lobby for a change in attitude towards direct individual share ownership. The big institutions are not going to do it, so it is left to private investors and retail stockbrokers to do so. Let their voices be heard.

This article first appeared on bdlive.co.za.