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Pay debt or invest?

Aug 15 2012 16:45

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A Fin24 user asks:

After my house had been paid off I landed up with a divorce, where the only solution I saw was to keep my house and pay my ex an amount of money. This led to me taking a bond on the house.

Currently, I am paying everything I can into my bond. I am 57 and concerned that I am feeding all my money into a bond. I am not saving any other way. 

I was thinking to perhaps contribute to a platform group investment unit trust like Coronation and Allan Gray and reduce how much I put into the bond. My bond is at a preferential rate of 1% below the standard bond rate.

Do I place a portioned monthly amount into a platform investment or do I keep paying on my bond?

Jan-Carel Botha, financial planner at Ultima Financial Planning, advises:

This is one of the most common questions: pay debt or invest?

What’s important is to remember that ultimately one’s balance sheet is affected in the same way whether you pay your bond, thus reducing your liabilities OR increase your investments, thus increasing your assets.

Looking at this, paying additional monthly lump sums into your bond is definitely a form of saving. The question is really which is better from a financial planning and investment return view point?

Firstly, when I do retirement planning for clients, which I assume you consider being age 57, one of the key goals is usually to be debt-free at retirement.

Various risks and considerations such as interest rate fluctuations and monthly budgeting needs makes this a sound and logic goal.

Ultimately you have to get the bond paid at some stage, and preferably before retirement.

And now an answer to the second question I assume you are eager the know - which will give you a better return?

You have to realise that the interest you pay on your bond is a “guarantee”. You are charged this interest as long as the rate is at this level.

This implies that if you then pay additional lump sums into the bond, you are “guaranteed” of a saving/return on your money of prime less 1%, in your case 7.5%.

Comparing this “guaranteed” return of 7.5% to other short-term guaranteed investment products, this is a very attractive return and I would even go as far to say, basically unmatched in the current short term guaranteed investment market.

Unfortunately it doesn’t end here.

You have to also consider the longer term rather than just the short-term guaranteed return, as I assume you want to invest for your retirement, which brings along much longer time horizons.

You should therefore compare your 7.5% “guaranteed return” with a long-term “non-guaranteed return”.

It’s difficult because we are not comparing apples with apples.

This being said, the returns of many investment funds such as those of Coronation and Allan Gray which you have mentioned, have significantly outperformed the prime interest rate.

Chances are that they will repeat this, but it’s not a guarantee.

I suggest that you consult a professional financial planner, preferably one that holds the CFP® designation to ensure minimum qualification and experience, to help you consider all these factors as well as the rest of your balance sheet in order for you to make the most appropriate choice.

Disclaimer: Fin24 cannot be held liable for any investment decisions made based on the advice given by independent financial service providers.

Under the ECT Act and to the fullest extent possible under the applicable law, Fin24 disclaims all responsibility or liability for any damages whatsoever resulting from the use of this site in any manner.

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