The UK version of the tax-free account is called an ISA. ISAs were introduced in the UK in 1987, and the first ISA millionaire was minted in 2003. The purpose of a TFSA is to invest over the long term (as opposed to saving) with the specific goal of becoming SA’s version of an “ISA millionaire” yourself. Your long-term proceeds can then ideally be used to supplement your retirement income.  

Now that you know the rules that apply to TFSAs and how they work, how do you make the most of this tax-free investment vehicle? 

Invest as much as possible as soon as possible 

Start investing in a TFSA today. This applies especially to Millennials who can really reap the benefits of Compound tax-free growth over 20 years or longer. Compound interest is a powerful force and the quote “Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it,” is attributed to Albert Einstein.   

Stay invested for as long as possible 

The impact of remaining invested in high growth assets for very long durations is unbelievable. If you invest R3,000 pm for just under 14 years (when the R500,000 lifetime limit is reached) in global and SA equities, with an estimated annual return of 14% (in Rand), your TFSA will be worth R43.7 million after 40 years and R162.1 million after 50 years.  

Avoid Withdrawals 

Avoid withdrawals unless absolutely essential. It is far better to have a separate fund available for emergencies than to withdraw from your TFSA, thereby reducing the value of your TFSA. This is especially the case as once the lifetime investment limit has been reached it is not possible to invest additional contributions in your TFSA without incurring a 40% tax on these additional contributions.  

Maximise Long-term Returns 

Historically equities have provided the highest long-term returns. 

The table below shows the average annual returns for various high equity unit trust sectors at
31 December 2023 over various time periods from 5 to 15 years courtesy of Morningstar. 

• Over 10 years the funds providing the highest returns are global equity funds followed by global or worldwide multi asset high equity funds. 
• Over 15 years and longer periods SA funds’ relative performance improves compared to their global counterparts. 
• Remember that past performance is not a reliable indicator of future results.

Minimise Fees 

Obviously, all things being equal, it is better to pay lower fees than higher fees. However, higher fees are fine, as long as the expectation is that they will be more than offset by higher long-term returns. Very few investors have been able to outperform the S&P 500 Index over long periods of time. Warren Buffet and Berkshire Hathaway have done so by a significant margin since 1965.

However, over the last 20 years the S&P 500 has marginally outperformed Berkshire Hathaway stock.  You can purchase a broad based Index Fund such as the MSCI World Index or S&P 500 Index fund or Exchange Traded Fund (ETF) with a Total Expense Ratio (TER) of as little as 0.2% to 0.25% pa. This is a saving of 0.5% to 1% on the better actively managed Global Equity unit trusts available in South Africa. 

Diversification 

Given the long investment horizon diversifying by asset class is less important, as short-term market fluctuations (losses) should not concern the long term TFSA investor. Diversification across a broad spectrum of companies and geographies is good practice. To illustrate this, the best performing global equity funds over the last 5 years (at end of September 2024) are those that focussed on Technology companies (28% pa), while the worst are those investing in Emerging Markets (<10% pa) and S&P 500 ETFs produced a very good performance
(18% pa) in the top 10% of global equity funds. (Returns as per FundsData).

S&P 500 Index or MSCI World Index funds or ETFs are well diversified by design across 100s of companies and many industries. 

Remember that past performance is not a reliable indicator of future results and Technology companies may not perform as well in the future. 

Importance of High Long-Term Growth 

Choose a fund or funds with care. The difference between an average return (or below average) and top quartile or better return can be material. 

For example, a 25-year-old investing R3 000 pm for just short of 14 years (until reaching the lifetime maximum cap of R500 000) in a global equity portfolio and leaving the TFSA to grow until age 65 would have grown the funds as follows based on the assumptions below: 

*  This represents the present-day value of the investment at age 65. For example, in the table above, the TFSA growing at 8% pa grows to a value of 6.7 million at age 65, but that 6.7 million is only worth 1.0 million today.
** Similarly, this represents the present-day value of the actual monthly income at age 65.

As can be seen from the table above the long-term return earned over a 40-year period makes a massive impact, with a 14% return (associated with equities) providing a value which is 6.5x greater than an 8% return (associated with a fixed interest investment).  

In conclusion, maximizing your TFSA requires understanding the limits, consistent contributions, and smart investment choices. By following these strategies, you can make the most of your TFSA.  

A TFSA is one of the best investments you can make as a South African, if you know the rules and employ them effectively! Start today, invest for high growth and remain invested for as long as possible to allow compound interest to do its work and secure your financial future.  

Maybe your child will be the first TFSA billionaire in 60 years or so!