Should You Invest Your Extra Cash or Pay Off Your Mortgage?
“Home is where one starts from” (T. S. Elliot)
If you have some extra cash, you may well be wondering how best to make use of it. Very often the choice comes down to deciding whether to invest it for long-term growth, or to pay down your debt.
Since the biggest debt that most people carry is their home loan, this is usually where they look. Does it make more sense to put money there, reducing your monthly payments, or to put it away for your future?
There is no simple answer to this question. The right choice for you will depend on things such as your age, how much you owe on your bond, and what other assets you have.
Nevertheless, there are some things that anybody in this situation can think about:
Rate of return
At the moment, interest rates in South Africa are at multi-decade lows. Unless you fixed your home loan interest rate at a higher level, that means that you will be paying somewhere around the current prime lending rate of 7.0%.
If you put excess money into your bond, you are effectively securing that as the tax-free return on your money. This is because you are reducing the capital amount, and therefore saving yourself the interest.
By comparison, balanced funds in South Africa expect to deliver a return of inflation plus 4.0% to 5.0%. At the moment, that would be somewhere between 8.0% and 9.0%.
Theoretically, the return on a balanced fund investment therefore looks more attractive. However, returns in South Africa have only averaged around 6.0% for the past five years.
Risk
That highlights the second point to consider, which is that if you put the money into your bond, you know exactly what your effective return is. If, on the other hand, you invest the money, your future returns are less certain.
Markets are always going to be unpredictable. They could deliver more, or they could deliver less. The decision about where the best place to put your money therefore depends on how much risk you are willing, and able to take.
Tax
It’s also important to note that the effective return that you get from paying off your mortgage is tax free. If you invest the money, however, you will pay tax on the interest and (eventually) any capital gains.
An exception would be if you invest into a tax-free savings product. There is, however, an annual limit of R36 000 on these funds.
You could also invest a lump sum into a retirement annuity. This would reduce your taxable income for the current year and therefore have an immediate tax benefit. You would, however, still pay tax whenever you take the money out.
Diversification
While paying money into your bond is risk-free in the sense that your return is guaranteed, it does come with a different kind of risk: you would be putting all of that money into a single asset. Property may seem secure, but there are plenty of stories of people losing money because property prices fell.
The benefit of investing into a unit trust or retirement annuity is that your money would be spread across a variety of investments. You would therefore have the security of not having all of your eggs in one basket.
Liquidity
If you have access to your bond, putting money into your home loan means that it is possible to take some out again if you should ever need it. This is also true of conventional unit trust products.
If you use a tax-free savings account, however, you don’t want to be making withdrawals unless you really have to. This is because once you have invested into one of these products, you reduce your lifetime limit, and you never get that back again.
In a retirement annuity, you are even more restricted. You cannot access this money at all until you turn 55.
Decision
Depending on your personal circumstances, there may be other things to take into consideration as well. These include whether you have sufficient savings in an emergency fund, and what your time horizon is.
To examine all of these questions and decide on the best approach for you, speak to your financial adviser.
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