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A Fin24 reader writes:
I have R80 000 that is currently in a balanced fund at Allan Gray.
I also have two loans with Absa.
The first loan is for a house at an interest rate of prime minus 1.3%. I also have a vehicle loan at prime plus 0.5%.
I am thinking of taking the R80 000 and paying this into one of the two loans.
At the end of the day, I would have saved more than I would have made had I left the money in the balanced fund.
If I decide to take the R80 000 and help pay off a loan, would it make the most sense to put this towards the loan with the highest interest rate - in this case the vehicle loan?
Two experts advise:
Don Richter, an accredited financial planner with PSG Konsult in Houghton, responds:
While your proposal technically makes sense - ie substituting the Allan Gray Balanced Growth Fund for the most expensive loan - you are also sacrificing your only equity-related growth investment.
One should only consider such a switch if reasonable doubt exists whether the equity investment will outperform the loan over the medium term, or where the investor desperately needs to improve his or her cash flow to meet requirements.
The Allan Gray Balanced Growth Fund performed 12.8% over one year and more consistently 11.9% per annum over five years.
While the historic performance is certainly no indication of how the fund will perform over the next one or two years, we would be disinclined to suggest cashing in this investment to settle a non-growth asset over the medium term.
It all boils down to financial discipline.
It is, of course, preferable not to have debt in the first place and common logic dictates that it should be settled first. However, our experience has shown that people naturally have a higher tendency to incur more debt than to invest towards securing a better retirement. It therefore takes more discipline to invest than to repay debt or not to incur new debt.
A further point to consider is one of costs when exiting an investment and for settling the debt early.
Even though Allan Gray does not charge initial fees, some managers of other unit trusts may charge an initial fee for reinstating the investment at a later stage.
Moreover, the bank is likely to levy a penalty for settling the debt early if you don't give it notice of your intention three months early.
On the assumption that the investor seeks better returns rather than being concerned over his ability to repay the vehicle loan, we would recommend cashing in half of the balanced growth investment in favour of the vehicle loan and switching the other half to the more equity-rich Allan Gray Equity Fund.
Almo Lubowski*, a certified financial planner, also responds:
At the outset I would like to say that there are varying opinions on this type of question. I will not answer it in the direct manner you would have probably hoped for – besides, I can't really give you "advice" in any event as that is heavily regulated.
I will attempt to give you some guidance and important factors to consider in coming to a decision.
It is also important to note that it is always a good idea to build a personal relationship with a good adviser. Find a professional adviser through the Financial Planning Institute of Southern Africa (FPI). You can find one, according to your requirements and locality, on www.fpi.co.za.
To make this decision, it will be a good idea to do some calculations. Paying off your home loan faster will create savings, there is no doubt. But you need to always match those savings with the time value of money. (This is the basic idea that a rand today is worth more than a rand tomorrow.) An amount of R100 000 today is not going to buy you the same things in 20 years' time.
So, often the amounts that you save by paying off your home loan early won't have the same value 20 years from now. Without even taking serious growth into account, the difference between having invested that money or keeping it in something like a balanced fund could be minimal.
You will, however, need to do various calculations.
Using the R80 000 as a down payment and to settle the costs of purchasing an investment property may be another idea to consider - provided you have considered the risks and general duties involved in becoming a private residential property investor.
Renovations to your current property to assist in raising its value could be yet another consideration.
These improvements could reduce your capital gains when you sell, especially if they are maintenance-related.
After having looked at all the calculations and considered all the options, you also have to trust yourself and do what makes you comfortable. Having a lower home loan instalment to pay each month may just put your mind at ease.
The main difference between the car loan and the home loan is that the property is an appreciating asset, while the car is a depreciating one.
So paying off your car would probably be a stronger consideration - especially if you are not using it for work purposes and not claiming work travel each year by way of a logbook. There are some tax considerations if you are using your car for work purposes, and if you are operating a sole proprietorship or earn commission.
What I have not mentioned and what will need to be considered - although this is by no means an exact science - is the investment growth of your current investment.
Interest rates are relatively low historically in South Africa at the moment, although the prime rate - 9% - is still relatively high in the global context.
Nevertheless, growth in equity investments is usually higher than that.
So, as mentioned, these varying interest savings achieved on paying off loans early - compared with interest achievable on other investments - need to be part of your calculations. In addition, the time value of money also needs to be considered so that you can compare apples with apples.
• Lubowski heads up the technical department at the FPI, but is answering these questions in his personal capacity and not as an FPI employee. Where appropriate, the information does not constitute financial advice. While every attempt has been made to ensure accuracy, the writer cannot be held responsible for any errors that may occur.
Before making any decisions based on the contents of this communication, the reader is urged to consult a licensed financial adviser.
I have R80 000 that is currently in a balanced fund at Allan Gray.
I also have two loans with Absa.
The first loan is for a house at an interest rate of prime minus 1.3%. I also have a vehicle loan at prime plus 0.5%.
I am thinking of taking the R80 000 and paying this into one of the two loans.
At the end of the day, I would have saved more than I would have made had I left the money in the balanced fund.
If I decide to take the R80 000 and help pay off a loan, would it make the most sense to put this towards the loan with the highest interest rate - in this case the vehicle loan?
Two experts advise:
Don Richter, an accredited financial planner with PSG Konsult in Houghton, responds:
While your proposal technically makes sense - ie substituting the Allan Gray Balanced Growth Fund for the most expensive loan - you are also sacrificing your only equity-related growth investment.
One should only consider such a switch if reasonable doubt exists whether the equity investment will outperform the loan over the medium term, or where the investor desperately needs to improve his or her cash flow to meet requirements.
The Allan Gray Balanced Growth Fund performed 12.8% over one year and more consistently 11.9% per annum over five years.
While the historic performance is certainly no indication of how the fund will perform over the next one or two years, we would be disinclined to suggest cashing in this investment to settle a non-growth asset over the medium term.
It all boils down to financial discipline.
It is, of course, preferable not to have debt in the first place and common logic dictates that it should be settled first. However, our experience has shown that people naturally have a higher tendency to incur more debt than to invest towards securing a better retirement. It therefore takes more discipline to invest than to repay debt or not to incur new debt.
A further point to consider is one of costs when exiting an investment and for settling the debt early.
Even though Allan Gray does not charge initial fees, some managers of other unit trusts may charge an initial fee for reinstating the investment at a later stage.
Moreover, the bank is likely to levy a penalty for settling the debt early if you don't give it notice of your intention three months early.
On the assumption that the investor seeks better returns rather than being concerned over his ability to repay the vehicle loan, we would recommend cashing in half of the balanced growth investment in favour of the vehicle loan and switching the other half to the more equity-rich Allan Gray Equity Fund.
Almo Lubowski*, a certified financial planner, also responds:
At the outset I would like to say that there are varying opinions on this type of question. I will not answer it in the direct manner you would have probably hoped for – besides, I can't really give you "advice" in any event as that is heavily regulated.
I will attempt to give you some guidance and important factors to consider in coming to a decision.
It is also important to note that it is always a good idea to build a personal relationship with a good adviser. Find a professional adviser through the Financial Planning Institute of Southern Africa (FPI). You can find one, according to your requirements and locality, on www.fpi.co.za.
To make this decision, it will be a good idea to do some calculations. Paying off your home loan faster will create savings, there is no doubt. But you need to always match those savings with the time value of money. (This is the basic idea that a rand today is worth more than a rand tomorrow.) An amount of R100 000 today is not going to buy you the same things in 20 years' time.
So, often the amounts that you save by paying off your home loan early won't have the same value 20 years from now. Without even taking serious growth into account, the difference between having invested that money or keeping it in something like a balanced fund could be minimal.
You will, however, need to do various calculations.
Using the R80 000 as a down payment and to settle the costs of purchasing an investment property may be another idea to consider - provided you have considered the risks and general duties involved in becoming a private residential property investor.
Renovations to your current property to assist in raising its value could be yet another consideration.
These improvements could reduce your capital gains when you sell, especially if they are maintenance-related.
After having looked at all the calculations and considered all the options, you also have to trust yourself and do what makes you comfortable. Having a lower home loan instalment to pay each month may just put your mind at ease.
The main difference between the car loan and the home loan is that the property is an appreciating asset, while the car is a depreciating one.
So paying off your car would probably be a stronger consideration - especially if you are not using it for work purposes and not claiming work travel each year by way of a logbook. There are some tax considerations if you are using your car for work purposes, and if you are operating a sole proprietorship or earn commission.
What I have not mentioned and what will need to be considered - although this is by no means an exact science - is the investment growth of your current investment.
Interest rates are relatively low historically in South Africa at the moment, although the prime rate - 9% - is still relatively high in the global context.
Nevertheless, growth in equity investments is usually higher than that.
So, as mentioned, these varying interest savings achieved on paying off loans early - compared with interest achievable on other investments - need to be part of your calculations. In addition, the time value of money also needs to be considered so that you can compare apples with apples.
• Lubowski heads up the technical department at the FPI, but is answering these questions in his personal capacity and not as an FPI employee. Where appropriate, the information does not constitute financial advice. While every attempt has been made to ensure accuracy, the writer cannot be held responsible for any errors that may occur.
Before making any decisions based on the contents of this communication, the reader is urged to consult a licensed financial adviser.
