Income vs Capital Growth
One of Franc's unique selling points (which our customers love) is that we try to keep things as simple as possible. It is for this reason that we currently only offer two funds on the platform, the Allan Gray Money Market Fund and the Satrix 40 ETF. We have previously explained what a money market fund is here and what ETFs and shares are. One of them earns you income, the other increases your wealth through capital growth (and possibly income too), so what's the difference?
Money market fund
In summary, when you invest in a money market fund, you are lending out money to government and large institutions who then pay you interest on the money you are lending them. The likelihood that they will not be able to repay you is very small so the chances of you losing any money is extremely low - your initial investment or capital is in extremely safe hands. With money market funds, the unit price remains the same so the only form of return is the interest or income earned.
When investing in the stock market in equity ETFs or shares, you are investing in businesses and are hoping that they perform well and that their share prices go up. The share prices of companies can go up or down in the short term so they can be quite volatile - their prices depend on supply and demand. Higher demand for a share pushes the price up whilst if there are lots of people selling (more supply) this will push the price down. Supply and demand will depend on general market dynamics (ie. the Russia/Ukraine war will make investors jittery and cautious and will generally cut demand and increase supply) whereas if a specific company posts very good results that the market was not expecting - this should have a positive impact on the company's share price even if the rest of the market is suffering.
Companies also pay dividends when they have excess cash - this goes to shareholders and is effectively income earned on the shares.
Differences between income and capital growth
As you can see, the money market fund does not provide any capital growth opportunity - the only return is the interest (income) paid out every month. This is why these investments are best for short term horizons as your capital is secure and you earn a return better than most banks which normally keeps up with or beats inflation.
However the share/equity ETF investment can go up or down in value (history has shown us that if you are invested for a long period of time your equity investment generally increases in value) so does provide capital growth opportunity as well as potential income through dividends paid out by companies/funds. These investments are best when you have a longer term horizon so you can ride out the bumps.
A property you own is another example of an investment that has capital growth potential (you hope to sell it for more than what you pay) and if you rent it out, you can also earn income on your investment.
Different tax treatment
Income earned and realised capital gains (when you sell something for more than you paid) have different tax consequences. South Africans under 65 years of age can earn R23,800 of interest every year without paying tax on interest earned (you need to have around R500,000 invested in a money market fund to earn this much).
If you own shares in local companies that pay dividends you will be automatically taxed 20% on these dividends. This will be taken off before you receive the dividends and paid to SARS on your behalf.
South Africans under 65 are also exempt from any taxes on capital gains for the first R40,000 gain made every year. After that you will start owing the taxman at a rate of 40% of your marginal rate. ie if your marginal rate is 26%, you will have to pay 10.2% (40% x 26%) of your annual gain over R40,000 in tax. This is only triggered once you actually sell the investment.
You need both types of investments
When you are starting off, an emergency fund should probably be your priority - build up 3-6 months of your monthly expenses so that if you run into any unforeseen issues you are covered. This should be in a low risk, interest bearing account like a money market account.
Once this is sorted, start preparing for the future - invest in low cost equity ETFs that give you capital growth potential over the long term and which will set you up for those major life events like paying for your kids education and funding your own retirement.