Liberty Newsletter April 2018 View the newsletter online
Should you be investing if you have debt?
 
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If you've been investing while also struggling to manage your debt, you could be doing your financial future a disservice. When you separate your debt obligations from your savings and investments, your debts could be eating away at your overall wealth.

On the other hand, if you implement a strategy that focuses only on paying off debt and ignores investing, you could find yourself vulnerable to unexpected events, as well as under-funding in retirement. Managing debt and investments is a double-edged sword, but there is a solution.

Successfully paying off your debts while growing your savings and investments requires a balanced approach.

Six ways to balance your debts and investments

1. Establish an emergency fund
Before you start accelerating your debt repayments, you should ensure that you have an emergency fund of at least R10 000-R20 000. Most attempts to become debt-free are derailed by emergencies, which force people to access credit lines. Over time, you should ideally build this fund up to three- to six-months-worth of expenses.

Building up an emergency fund doesn’t mean you should ignore your debt repayments. Always pay the minimum monthly requirements on your debts to maintain a healthy credit record.

2. Use short-term savings to pay off short-term debt
In the example below, you'll see that by using a money market savings account to pay off short-term debt, you would effectively have a 19% return on your money. You would have saved 25% (paid to the bank), but lost out on the 6% interest on your savings. 19% is the best return you could hope to get on a short-term investment. You can use the money you would have paid on your monthly credit card payments to top up your money market account.

This example shows how you can save by clearing your short-term debt:

SAVINGS DEBT
R20 000: Money market account R15 000: Credit card
6% per year interest earned 25% per year interest owed

3. Increase your short-term debt repayments
In the example below, you'll see that by using an additional R600 to pay off a 24-month loan within just one year, you would have saved R2 000 in interest. The following year, you can start putting extra money into longer-term savings as you now have R1 400 (R600 savings and R800 debt repayment).

This example shows how you can save by increasing your short-term debt repayments

SAVINGS DEBT
R600 a month: Bank Account R800 a month: Personal Loan
(Minimum instalment, 24 months)

4. Cut five years off your bond
By increasing your bond repayments by 10%, you will pay off your home loan five years earlier. On a R1 million home loan, you would save around R420 000 in interest. And when interest rates go up, you will already be paying the new, higher minimum repayment amount, so you won’t have to change your budget to accommodate the increase.

5. But… don’t put all your money into your home loan
It's not a good idea to invest all your savings into your home loan. Your house is not a retirement asset, rather it is a life asset that needs to be paid off over time. If you put all your money into your home loan, you may be debt-free, but you’ll have no funds to put into your retirement fund. Putting all your money into your home loan is also a high-risk strategy as you are betting all your savings on your home. You should diversify your savings into other asset classes such as equities (shares).

6. Don’t ignore retirement funding
Even if you have debts to repay, make sure you continue to invest 15% of your monthly salary towards retirement. When it comes to retirement funding, time is literally money, because of the power of compounding.

For example, if you saved R1 000 per month from the age of 25 to 30 and never contributed again, you would still have more money for your retirement than if you contributed R1 000 per month from the age of 30 to 65. This is because, on average, your money doubles every seven years, making those first seven years extremely valuable.

If you need advice on how to balance your debt and savings, schedule time with your financial adviser. Take this article with you and together you can assess which solution is best for your situation.

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The information contained in this communication, including attachments, is not to be construed as advice in terms of the Financial Advisory and Intermediary Services Act of 2002 ("FAIS") as the writer is neither an appointed representative of Liberty, nor a licensed financial services provider as contemplated in FAIS. Please consult your financial adviser should you require advice of a financial nature and/or intermediary services.