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Emergency fund or extra money in a bond?

A Fin24 user wants to know if an emergency fund or extra money in his bond is a better idea. He writes:

Which would be better, creating an emergency fund or putting that extra cash into a bond?

Matthew Chapman of NFB Financial Services responds:

Your question is very open-ended. In order to make a proper judgement we would require some more information.

This would include your bond rate, the remaining amount owed on the bond, your short-term liquidity needs and any existing "emergency" provisions that you have.

For the purpose of a general response, I’m going to assume that you do not currently have any funds set aside for unforeseen expenses and that your bond is priced at prime, with no access facility and with over 10 years remaining on the existing debt.
 
On the one hand, it must be noted that we are in a rising interest rate environment and we have already seen two increases in the repo rate this year, amounting to a total of 0.75%, resulting in prime sitting at 9.25%.

We, together with a large portion of the market, do not feel that this is the final move we will see.

This is due to the fact that inflation is upward of the 3% to 6% target range and the policy the SA Reserve Bank (Sarb) have adopted to bring this back below 6%, is the hiking of rates.

With this single fact in mind, it would be wise to settle as much existing debt as possible at lower rates as your monthly bond payments will only increase accordingly, in line with any further contractionary monetary policy moves by the South African Reserve Bank.
 
However, if we look at the other side, it’s always sensible to plan for emergencies by setting aside some cash for unexpected expenses.

The last thing you want is to have to take out further debt at increasing rates to pay for something you don’t have the cash to afford.
 
If, however, your bond were structured as an access bond, then it may well be sensible to put any surplus cash into the bond with the knowledge that you can always take it out should you need to at a later date.

Without getting too technical, again it would be dependent on the term and prime-linked rate on your bond.

So, it really comes down to a personal choice in the end. Yes, it would be wise to settle debt in a rising interest rate environment, but I would caution against not having any provisions for emergency expenditure.

- Fin24

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