Fin24

Pay debt or invest?

2012-08-15 16:45

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.

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Comments
  • john.merwe.3 - 2012-08-17 10:11

    the obvious problem with paying off your bond as apposed to building liquid capital is that you will need accessible cash to live on at retirement. This means selling your house or renting it out. I have seen this very problem with many clients in the past. Whichever way you cut it one has to assess whether you can afford to pay off your house AND have cash available. otherwise sell now, downgrade in terms of size and reinvest the excess capital. Better than being forced to do so after retirement.

  • ariado.myfather - 2012-08-17 11:09

    What kind of question is that? Is that the typical South African culture to spend first before paying the debt?

  • bruce.dakers.9 - 2012-08-17 21:26

    An important part of the guaranteed 7,5% in the bond, is that this is also tax free.

  • commercial.property.sa - 2012-08-20 07:12

    Be bold...If you have excess monthly income, buy an entry level townhouse or two to let and raise bonds on these ensuring that the NET OPERATING INCOME and your monthly excess income covers the bond...you can get 100% funding or use your existing home as collateral. Budget your acquisition pricing at funding over 10 years at 3% above current interest rates. Structure your actual funding loan over 15 to 20 years at Prime - 1%, if you can. This strategy will ensure your income is free and clear of monthly expenses. As rentals escalate, pay the excess into the bonds and after 10 years you will have paid off the bonds...now you have 3 properties which only cost you that monthly excess income you had...one to live in and two bond free rental income streams. If your are bold enough, you could expand this into a portfolio of properties given the correct guidance. Always consult a property professional when investing in property (property asset manager, property auditor or the like)...never a financial adviser who are mostly biased to advise on cash, bonds and equity (where they generate annuity income for themselves) and generally do not comprehend the full advantages of property investments over other asset classes.

  • lee.vanrensburg.9 - 2012-08-24 11:27

    You have look into what your debt is costing you versus what return you expecting from an investment. Given the level of interest rates, you are more likely to get get a higher investment return. So why settle debt that is costing you 8% when you can earn approximately 11%? Keeping your debt will net you 3% for an example. If interest rates and investment return change positions, settle your debt. Quick, simple and in plain english. stay away from a broker who wants to sell you an insurance based investment, or an investment from an insurance company.

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