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By Stefan Janse van Vuuren*
There is a certain comfort around knowing you are going to retire debt-free. But that peace of mind should be weighed against solid financial facts.
When it comes to paying off a bond, for example, first take a look at the reigning interest rate. “If the rate on the mortgage is low, whether you have a preferential rate or in the current low rate environment, you might be better off holding investing it elsewhere, assuming you’re reasonably confident you can get a higher rate of return.
But, at the same time, reducing debt, and ideally eliminating it, all else equal, should be on your list of goals before retirement.
Also, apart from South African sovereign bonds, the local investment scenario has not shown much sign of growth for some time now, so if your offshore allocation of your portfolio has been exhausted, and with interest rates at record lows, it might be a good time to offload some of that debt burden and free up some cash for future reference.
The Reserve Bank’s monetary policy committee (MPC) left the benchmark interest rate unchanged at 3.5% recently even as two members of the committee voted for a cut and it downgraded its inflation forecast for 2021 slightly.
Note that not all debt or investment is equal. The type of structure or platform will make a huge difference.
But it is worth keeping in mind that it is hard to get a plus 3.5% guaranteed investment return from any investment today. Being “reasonably confident” you get a higher rate of return involves risk. It is important for your advisor to evaluate your risk tolerance, in context of your financial circumstance, and take any decision.
But more importantly do not fall victim to the temptation of refinancing your home at a time like this and when borrowing costs are low, by spending it on building upgrades or luxury living.
But there are plenty of positives of paying off your bond before you enter your golden years.
For one your mortgage payments may represent a significant chunk of your monthly expenses. Eliminating that can greatly reduce the amount of cash required to meet your obligations and be allocated to increased health costs or safety features.
Furthermore, falling into or deeper into credit is easy and expensive. Simple math would suggest that it is better to settle high-interest debt before saving for retirement or adding to your emergency fund. Generally, if you are paying more interest than you are earning in interest, you are losing money. If you pay your debt first and put no money in savings, the downside is that you will have nothing but your credit cards to fall back on if you have a financial emergency.
You can count on some type of expense coming, and it is usually when you least expect it. The Covid-19 crisis is a case in point. Using your credit cards to fund an emergency only makes it harder to pay off debt, and short-term loans eventually run out of steam, especially if you are unemployed or are living on a fixed income.
Investments can go up or down but eliminating borrowing costs from the equation can be like earning a risk-free return equivalent to the prime interest rate, taking inflation into account. And relatively confident of earning a return that exceeds your bond rate is not the same thing as being certain of earning that rate. There is a risk of loss too.
You might need to adopt a blended approach and save some while you pay down some of your debt at the same time. As soon as your advisor makes you understand the pros and cons of either situation, you can better assess your own situation and see how to tweak your savings and debt payments to move your goals forward in each area.
No navigate the options, as with all financial planning or personal finance decisions, it is advisable to consult with a qualified and experienced financial advisor who has the tools available for you to make an informed choice. Between deciding whether to pay down debt or to invest, or bit of both, they will help you consider your best investment options, determine your tolerance towards investment risk, and help you manage your cash flow.
Read more about retirement planning.
- Stefan Janse van Vuuren is a financial advisor at Brenthurst Wealth Stellenbosch office. firstname.lastname@example.org.