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Investing fundamentals
Inflation
Inflation means that as prices of goods and services go up, the purchasing power of your money decreases and you have to pay more than what you are used to. In South Africa inflation is measured using an index called the Consumer Price Index (CPI). This measures how the price level of consumer goods and services used by a household increases between two periods of time. Failing to get a return (reward) that beats inflation means you are actually losing money to a certain degree.
For more information on SA Economic indicators, you may also visit the economics forecast section .
Compounding Interest
Compounding refers to the process of earning interest on interest. In other words, with compound interest you earn interest not only on the initial investment or saving, but on the Investment plus the interest received to date.
If you do not reinvest the earnings that you make from the interest but take it out each year, firstly your annual return will be less and secondly your capital will not grow
Over the long-term, great things happen to investments. The interest you earn adds up over the years and before you know it a little pile of cash can turn into a mountain.
Capital versus Income Growth
Investments have the potential of offering an investor two major types of returns (rewards); understanding the difference between the two is very critical:
Capital Growth/appreciation
This is the profit you make when you sell something (asset) for more than the price you paid for it. You do not have access to this profit until the asset is sold.
Income
Occurs when your investment generates cash income that you can access for example:
- Dividend income. This is the profit share paid to you as a shareholder of a company.
- Interest income. This is the interest you earn on the money you have invested with a bank. Refer to Compound Interest for further details.
- Rental income. This is income received in respect of a property that you rent out.
Simply put, investment income is a collective term used to describe interest, dividends, rental income, royalty or any other form of income earned on an investment.
Investments and Tax
Tax influence on investments, there's nothing for mahala (free).
Tax always plays a part in the investment decision, because every type of investment incurs some type of tax. Individuals pay two types of tax on investment returns, income tax and capital gains tax . The basic principle is: the more you earn, the higher the tax that you pay.
In simple terms, capital gains tax is payable on the profit you make when you sell your investment (asset). Income tax is payable on income earned on your investment. Note that dividend income is tax free.
When you invest, you should do some research and become aware of exactly how your investment will be taxed. Understanding the tax effects on your personal financial plan is very important. For more information on taxation you can visit www.sars.gov.za .