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SHOULD you pay off your bond with a cash windfall? Make sure you understand what the trade-offs are, says a financial planner.
A Fin24 user writes:
I have never been wealthy but recently became one of those people to benefit from the property price boom of a few years back.
I now have access to R1m in cash and have not got a clue what to do with it. We have an existing bond of R800 000. Many people say I should pay it off.
This probably sounds strange, but the way I look at it is as follows: my current home is probably worth about R1.8m and I have R1m in the bank. If I pay off the bond, I still only have a property worth R1.8m and the R1m cash has gone!
We can comfortably afford the current bond payments so while we can, we are thinking of putting the cash to work for us. I also have a company pension and provident fund, plus other retirement annuities that I contribute to monthly.
I am very naive when it comes to investing and really need advice, or to build a relationship with someone I feel I can trust.
Rowan Williams, private client relationship manager and financial planner at Sasfin, responds:
Assuming you have totalled up all of your bond repayments on that property over the full term of the bond, and you have in fact come out with a profit of R1m, congratulations.
Sometimes people forget to total up all their payments, including the interest, over the years and actually haven't benefited nearly as much as they think.
Either way, in current market conditions it is quite an achievement to sell this very illiquid asset.
If you do use the money to pay off your bond, you are investing in an asset class that gives you a return equal to your interest rate plus some capital growth - hopefully.
I say hopefully, because at the moment it is extremely difficult to sell property and many owners are finding that their real estate is actually worth zero because they cannot sell it.
It is important to remember that property is a capital asset and you need to find a buyer before there is a real cash value - ie no buyer, no cash.
On the subject of the return you are getting on your bond: negative/borrowed capital and thus a negative interest rate means positive real rate of return – the logic is weird.
Another way of saying it is that if you are paying 8.5% interest, you would effectively be investing in an asset that gives a positive return of 8.5%.
Have your cake and eat it
Yet another way of saying it is that interest on debt repayments has the same compounding effect as growth does on non-tangible investments like equities, and should be treated with the same logic. Having cash is nice because it is liquid and you can buy stuff with it.
However, you could have your cake and eat it to some degree if you were to use an access bond, which you could negotiate with your bank. The R1m would go into the property but would still be accessible. This could be a good parking option while you get the advice you seek.
This option would be similar to putting your money into cash or bonds in a return sense, and would decrease bond payments as long as the cash stays there.
You may or may not want to settle the bond now. Keeping it open could arguably be a way of keeping a credit facility open and available, but at a cost – a negative compounding interest cost.
Ask yourself: why would you want to keep paying your bank an annuity income for credit you don't need in the first place?
If you are happy with your answer and can convince a professional to accept it and work with you, then you are all systems go with respect to investing.
Having a pension and provident fund as well as retirement annuities is great. They are tax effective and indispensible parts of a holistic financial plan.
However, having them is not the same as knowing what the capital inside them can do for you in real terms.
You need to do a retirement analysis to calculate, in real terms, when your capital runs out in different scenarios.
Only then can you say that your retirement is secure. Keep in mind that bizarre aberrations in the international political economy can always still derail things if you are unlucky.
The retirement analysis should include your bond repayment obligations if you want to keep paying it off over the years.
You say that you need someone to give you financial advice.
To find someone you trust, I would recommend feeling it out until you recognise that you are in the room with intelligence, honesty and good vibes.
If you decide to continue with the bond and invest the money instead, then the discussion changes to the kind of asset classes/strategy that suits you.
To put things in perspective: today could be a good time to take a view on gold, but this could turn around in two years' time. So, maybe a better option would be a balanced portfolio consisting of a blend of asset classes.
In summary, a good financial adviser, with the right kind of tools, will be able to illustrate different options in terms of cash flow, capital growth, liquidity and so on.
The models are there to be used as tools. The financial adviser can point out options, benefits and shortfalls that the model doesn't know about.
Most importantly is you and what you want to do. A good adviser will base his or her advice on you and what you want out of life, though they will be straight with you and talk out the shortfalls in your system of wants, values and beliefs.
The right advice is not necessarily what you want to hear.
- Fin24
A Fin24 user writes:
I have never been wealthy but recently became one of those people to benefit from the property price boom of a few years back.
I now have access to R1m in cash and have not got a clue what to do with it. We have an existing bond of R800 000. Many people say I should pay it off.
This probably sounds strange, but the way I look at it is as follows: my current home is probably worth about R1.8m and I have R1m in the bank. If I pay off the bond, I still only have a property worth R1.8m and the R1m cash has gone!
We can comfortably afford the current bond payments so while we can, we are thinking of putting the cash to work for us. I also have a company pension and provident fund, plus other retirement annuities that I contribute to monthly.
I am very naive when it comes to investing and really need advice, or to build a relationship with someone I feel I can trust.
Rowan Williams, private client relationship manager and financial planner at Sasfin, responds:
Assuming you have totalled up all of your bond repayments on that property over the full term of the bond, and you have in fact come out with a profit of R1m, congratulations.
Sometimes people forget to total up all their payments, including the interest, over the years and actually haven't benefited nearly as much as they think.
Either way, in current market conditions it is quite an achievement to sell this very illiquid asset.
If you do use the money to pay off your bond, you are investing in an asset class that gives you a return equal to your interest rate plus some capital growth - hopefully.
I say hopefully, because at the moment it is extremely difficult to sell property and many owners are finding that their real estate is actually worth zero because they cannot sell it.
It is important to remember that property is a capital asset and you need to find a buyer before there is a real cash value - ie no buyer, no cash.
On the subject of the return you are getting on your bond: negative/borrowed capital and thus a negative interest rate means positive real rate of return – the logic is weird.
Another way of saying it is that if you are paying 8.5% interest, you would effectively be investing in an asset that gives a positive return of 8.5%.
Have your cake and eat it
Yet another way of saying it is that interest on debt repayments has the same compounding effect as growth does on non-tangible investments like equities, and should be treated with the same logic. Having cash is nice because it is liquid and you can buy stuff with it.
However, you could have your cake and eat it to some degree if you were to use an access bond, which you could negotiate with your bank. The R1m would go into the property but would still be accessible. This could be a good parking option while you get the advice you seek.
This option would be similar to putting your money into cash or bonds in a return sense, and would decrease bond payments as long as the cash stays there.
You may or may not want to settle the bond now. Keeping it open could arguably be a way of keeping a credit facility open and available, but at a cost – a negative compounding interest cost.
Ask yourself: why would you want to keep paying your bank an annuity income for credit you don't need in the first place?
If you are happy with your answer and can convince a professional to accept it and work with you, then you are all systems go with respect to investing.
Having a pension and provident fund as well as retirement annuities is great. They are tax effective and indispensible parts of a holistic financial plan.
However, having them is not the same as knowing what the capital inside them can do for you in real terms.
You need to do a retirement analysis to calculate, in real terms, when your capital runs out in different scenarios.
Only then can you say that your retirement is secure. Keep in mind that bizarre aberrations in the international political economy can always still derail things if you are unlucky.
The retirement analysis should include your bond repayment obligations if you want to keep paying it off over the years.
You say that you need someone to give you financial advice.
To find someone you trust, I would recommend feeling it out until you recognise that you are in the room with intelligence, honesty and good vibes.
If you decide to continue with the bond and invest the money instead, then the discussion changes to the kind of asset classes/strategy that suits you.
To put things in perspective: today could be a good time to take a view on gold, but this could turn around in two years' time. So, maybe a better option would be a balanced portfolio consisting of a blend of asset classes.
In summary, a good financial adviser, with the right kind of tools, will be able to illustrate different options in terms of cash flow, capital growth, liquidity and so on.
The models are there to be used as tools. The financial adviser can point out options, benefits and shortfalls that the model doesn't know about.
Most importantly is you and what you want to do. A good adviser will base his or her advice on you and what you want out of life, though they will be straight with you and talk out the shortfalls in your system of wants, values and beliefs.
The right advice is not necessarily what you want to hear.
- Fin24
