The biggest tax-free mistake South African investors make

South African investors who use their tax-free savings accounts (TFSAs) for cash or low-return investments are missing out on the significant tax-free growth these accounts can deliver.

Using a TFSA to invest in growth assets like exchange-traded funds (ETFs), as opposed to merely depositing cash, could be the difference between having R120,000 or R382,000 in 20 years.

This is based on an example used by Prescient Fund Services’ head of strategy, Niki Giles, who recently outlined the benefits of investing in ETFs through a TFSA.

The TFSA was first introduced in 2015, forming part of a government initiative to encourage South African households to save and improve the national savings rates.

Unlike regular savings accounts that South Africans may open with their banks, a TFSA offers investors tax-free growth on their interest, dividends and capital gains.

“Any investment growth inside a TFSA is completely free of tax. That means no tax on dividends, no tax on interest, and no capital gains tax, whether you invest for five years or fifty,” Giles explained.

Recently, the annual contribution limit for a TFSA in South Africa was raised to R46,000, with a lifetime contribution limit of R500,000.

Once contributions have been made, they cannot be replaced if withdrawn. Another restriction for TFSAs is that they cannot be used to invest in stocks directly.

Aside from this, how South Africans choose to use their TFSAs is up to them. The accounts can be used similarly to a normal savings account, where cash is deposited on a regular basis.

However, Giles said taking this approach could see South African investors lose out on the full benefit of tax‑free compounding.

“Rather than using it for cash or low‑return investments, it generally makes sense to use this tax‑free allowance for growth assets such as equity ETFs,” she said. 

The difference between R120,000 and R382,000

Giles used a simple example to illustrate how significant the difference between normal cash deposits and investing in ETFs in a TFSA can be.

In this example, an investor contributes R500 per month into an equity ETF inside a TFSA and earns an average annual return of 10%. 

Over 20 years, that investor would contribute R120,000 of their own money. Yet, the value of the investment after two decades would be close to R382,000. 

“More than two-thirds of the final amount would come from growth rather than contributions, and because this investment sits in a TFSA, all of that growth would be free from tax,” she said.

In contrast, if the investor had merely kept those funds in cash, they would be left with only the R120,000 they contributed.

When it comes to the choice of which ETF to invest in, South Africans are spoiled for choice, with more than 125 ETFs and actively managed exchange-traded funds (AMETFs) listed locally.

Faced with this many options, Giles said many investors make the mistake of overcomplicating the choice and end up experiencing decision paralysis.

“A more helpful starting point is to think about two things: time and risk appetite. How long do you have to invest, and are you comfortable seeing volatility in your investment value over the shorter term?” she said.

“Most long‑term investors only need one or two well‑chosen ETFs to get started.” 

For an investor who is risk-averse or unsure how much risk they want to take on, Giles recommended a balanced AMETF where the asset manager makes the asset allocation decision on your behalf. 

“Otherwise, a broad global equity ETF, possibly complemented by a local equity ETF, is often more than sufficient,” she said.

“Success comes not from finding the ‘perfect’ ETF, but from contributing regularly, keeping costs low, and resisting the urge to tinker.”

The reason why Giles said an ETF is a good option for investors comes down to cost and the asset’s built-in diversification.

Since ETFs give investors exposure to a basket of assets, in one transaction, as opposed to a single company, diversification is essentially “built in”.

In addition, Giles explained that most ETFs are passive, meaning they track an index rather than trying to outperform it. “When the market rises, the ETF rises with it; when markets fall, it falls too,” she explained. 

“The advantage of this approach is cost. Passive ETFs typically charge far lower fees than traditional actively managed funds, and those savings compound over time.” 

“While there is no guarantee of superior returns, decades of evidence show that keeping costs low and staying invested often matters more than chasing standout performance.”