Now that you know the difference between saving and investing, you have your emergency fund on stand-by and you understand why time is more important than money, it’s time to pull the trigger on your first investment.
How shares make money
To recap, you can make money from shares in two ways. First, when a company you’re invested in makes a profit, they share some of that profit with you. This is called a dividend. It’s literally cash in the bank, which is why you love it the most. As long as you hold the share, you get the dividends.
The second way is by selling your share for a higher price than you paid. A share will be worth more because the company you invested in has done brilliantly and now has more assets than when you bought the share. Alternatively, other shareholders may think the company will do brilliantly going forward and are willing to pay more for the share than it’s worth just to be part of it. You only make money from a share in this way when you sell it.
I thought this was about free money
Okay, we confess: this is more about money that you’re not losing than money you’re getting.
Dividends are great, but when you earn them, you don’t get to keep all of them. Before the money even gets to you, the government takes 20% in tax. If you invested in property companies, the dividends you are added to your income and you pay tax on everything you earned in the year plus the dividends.
Selling shares at a profit is also great, except for the tax bit. Hold on to your hat:
- The first R40,000 you make in profit when you sell your share is free from tax.
- 40% of whatever is left after your free R40,000 is what you pay tax on.
- The tax you pay isn’t a fixed percentage, it’s linked to your income tax rate. If you earn very little, that’s okay. If you earn very much, it’s a problem.
If you’ve ever heard the term “capital gains tax” or “CGT”, this is what it is*. This tax can push you into a higher income tax bracket. You therefore don’t only pay tax on the money you made in your investment. You actually pay more tax on everything! Boo! Hiss!
I’m still waiting for the free money bit
When it comes to investing, the government doesn’t so much give us free money as it doesn’t take away the money we’ve already earned. They do this through tax incentives. In a retirement product, the government deducts what money you contributed to your retirement from your income so you don’t have to pay tax on it. This may sound like not much, but the impact can be huge. Maybe you’ve already felt it in the form of a fat tax rebate.
The other way is even more exciting.The government promises never to take any dividend tax or capital gains tax from you as long as you invest in a certain type of tax-free account**. If you’re new to investing and you have time to stay invested, this is the type of account you want to be opening.
Next week, we’re going to explain exactly how tax-free accounts work and how you can get one.
*Some fool is going to tell you CGT is 18%. They’re wrong.
**They’re called tax-free accounts, tax-free savings accounts, tax-free investment accounts or TFSAs. They’re all the same.
Being outstanding with your money doesn’t have to be hard. This series of articles will give you all the tools you need to get your house in order to start investing. Written by Just One Lap and sponsored by OUTvest, this series is the ultimate guide to outstanding money.