It pays to settle your debt

Schalk Louw, portfolio manager at PSG Wealth
Schalk Louw, portfolio manager at PSG Wealth

The Irish rugby team recently toured South Africa and I think most readers will agree that aside from the nail-biting and action-packed games that came with it, another huge attraction had to be the colourful supporter costumes. 

The leprechaun costumes in particular always take me back to childhood fairy tales, in which these mythical beings used to hide a pot of gold at the end of a rainbow. With this in mind, my focus this week won’t be on fairy tales, but rather the human belief that each person has a pot of gold waiting to be found somewhere. 

With local and offshore markets priced extremely high at the moment, investors tend to see their pot of gold in this asset class, often overlooking the simplest and most effective investment of all: personal debt. 

Most South African investors below the age of 50 still have some form of debt, of which mortgage debt tends to be the most common form.

But it’s when we take a look at South Africans’ personal debt as a percentage of personal after-tax income that this ratio becomes troubling.   

Quite a few private investors approached me recently with a need to invest extra capital, but they were unsure of which investment vehicle to use with choices ranging from endowments, unit trusts and linked products to direct shares and property, to name a few.

My first question to such an investor is always: “What is your current debt ratio?” 

Always start by saving on your debt. If you made a home loan worth R500 000 at the current prime rate of 10.5% 10 years ago (2006), your outstanding debt today would amount to R370 000. It would have taken you 10 years at an average mortgage payment of R4 992 monthly (more than R599 999 in total over 10 years) to pay off only R130 000 in debt. Shocking! But if you had paid (saved) an extra R1 000 per month, your outstanding debt would amount to only R159 000. Only R1 000 extra per month (R120 000 over 10 years), would have saved you a whopping R211 000 in total over this period.

If you had invested your R1 000 savings in an SA General Equity unit trust in 2006, and you were fortunate enough to pay no platform or adviser fees over this period, your investment also would have been worth exactly R211 000 today. 

This looks like a fairly decent return on your investment at 10.5% per year (including a great correction and a recession over this period), and definitely would have left you in a better position than those who opted for money-market or bond investments. Sadly though, this return is before any tax deductions and once you deduct those, your returns look considerably weaker when compared to settling your outstanding debt.  

It certainly hasn’t always been the most pleasant of environments in the world of shares, and through this we learn that the simplest investment, depending on your particular situation of course, may often be the best. There is no doubt that each investment has a proper time and place and I definitely don’t want to discourage readers from investing in shares.

My recommendation is simply to start investing by paying off your debt first, and then moving on to other types of investments. 

Unlike paintings, the more expensive investment doesn’t always mean it’s the better investment and many people have fallen into this trap over the years.

Your pot of gold may be as close as paying off that little extra on your mortgage, but the secret lies in starting today. 

This article originally appeared in the 28 July edition of finweek. Buy and download the magazine here.



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