Investors are often told to get rid of their debt, including paying off their bond, before they put any money into the stock market. But is this always the right choice? Not according to Marius Fenwick of Mazars Moores Rowland Financial Services, who explains that it doesn’t make any sense to be debt-free at retirement but then have no savings to provide income.
Debt that is financed at a rate of 5% above prime should be settled as a priority. This includes overdrafts, credit cards and personal loans and even some hire-purchase agreements, which can also charge excessive interest rates.
But when it comes to paying off your bond, Fenwick says we should consider the numbers carefully.
If, for example, you have a bond of R800 000 at an interest rate of 11% and your bond period is 23 years, your bond repayment will amount to R7 986 per month. If you pay in an extra R1 000 a month in order to pay off your bond more quickly, your payment will then be R8 986 and your bond term will be reduced to 15 years and five months. If the full R8 986 is then invested for the remaining seven years and seven months (23 years less 15 years, five months) at 15%, you’ll accumulate an amount of approximately R1 446 600.
However, if you’d invested that extra R1 000 for the full 23 years at 15% growth, you’d end up with R2 063 296.
“Over an extended period equities will provide you with a better return than the interest saving on bond rates.”
In addition, a basic tenet of investing is never to put all your eggs in one basket. By paying off your bond at the expense of other investments, you’re doing just that. Additional money paid into your bond should only be with disposable income after you have taken care of your savings needs. Fenwick says it’s important to invest at least 10% of your disposable income into your retirement savings from as early as possible, irrespective of whether you have a bond or not.