A reader asks if it would be better to invest R500 000 in some investment mechanism or deposit it into my bond? The decision is not as simple as one might think.
It is a brilliant question and a conundrum that has been on many people's minds for as long as household bonds and saving have been in existence.
Paying off a bond to reduce debt has always been a good thing to do, but injecting all your savings into a bond could be at the expense of certain investment opportunities that can generate a better outcome in the long run.
In order to answer your question, we need to take into account the two different views: a traditional view that one needs to pay off home loans and any other debt as quickly as possible to avoid high levels of debt, and then a view that investing your extra cash into an investment instrument can be more beneficial for individuals in the long run.
Paying off a bond
People have been advised over the years that having debt, whether in the form of a household bond, credit card or vehicle finance, is bad and should be avoided or at least reduced as quickly as possible.
If you are to pay an additional lump sum value this will allow you to pay off the capital portion sooner, which reduces the term of the loan and hence reduces the total amount of interest paid.
Currently, with the Covid-19 pandemic having impacted the globe, South African interest rates are the lowest they have been in decades.
With the decrease in interest rates, paying a lower rate allows more money to go toward paying off the capital owed on the bond than going towards interest.
Something one needs to consider when paying extra money into your home loan is that this option does not provide you with liquidity if emergency funds are required.
The only time you can access any surplus funds easily if you have an access facility on your bond.
If you decide to invest the money, you can select an option that provides easy access to your funds should they be required.
If we think about the current situation that we find ourselves in, with many individuals having salary cuts and losing their jobs, having most of your cash reserves tied up in a household bond can be risky.
The investment option
Paying extra into your bond will always save you interest, but having exposure to the correct asset classes (equities, property, bonds and cash, both local and foreign) and investment products could over the long term save you more and could earn in excess of the interest rate.
Portfolio diversification is particularly important, and we always encourage investors to spread their risk and not be too concentrated in one asset class.
Putting all your money into a bond will mean you have too much exposure to property and will have all your eggs in one basket.
Different asset classes tend to perform differently during certain economic cycles, and therefore diversification will add value to your overall investment portfolio.
Investing in a unit trust would be a good option to consider as it will allow you to save while having the benefit of liquidity should you require the funds.
You could continue paying your home loan as you have been, and invest the R500,000 lump sum.
Depending on where you invest, you could gain enough interest monthly to be able to use part of the gains earned to pay a portion towards your monthly bond repayments.
The invested R500,000 also provides peace of mind and can be treated as an emergency pocket for unforeseen circumstances.
Another beneficial product to invest in would be a retirement annuity (RA). There are significant tax benefits for an RA investor.
Investors are permitted to invest up to 27.5% of their annual taxable incomes (subject to the R350,000 maximum per tax year) into an RA on a tax-deductible basis.
This saving can then be utilised to pay extra into the bond so reducing the interest and paying off the bond far quicker.
Please be advised that a RA does provide great tax benefits, but this investment is not liquid and is only accessible up to certain limits from retirement age which is age 55.
In conclusion, the decision is not as simple as one might think. It is recommended that you seek advice from a professional financial advisor who can analyse your current situation and guide you in the right direction towards your financial goals.
This article first appeared on Moneyweb and was republished with permission.
Michael Haldane formed Global & Local in 1999, after having achieved a BCom Honours at the University of KwaZulu-Natal and spending 8 years working for a number of financial institutions.
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