Settle your debt first, before you start saving……is this the best advice?
Paying off your personal loan
- Credit cards
- Store cards (Edgars account, Woolworths account)
- Personal loans
Often short-term debt such as the above comes with a high interest rate. By paying off these loans as quickly as possible, you guarantee yourself a return of what you would have paid in interest.
For example, have a look at the interest charged on your Woollies card, let’s call it 17%, by paying your loan off sooner rather than later you effectively guarantee yourself a return of 17%. No investment can guarantee you the same returns.
Bearing in mind, this strategy is only effective if you pay off and close these accounts, thereby opening up cash flow for savings. If you keep taking on debt and paying off debt, you will continue to chew into the funds you would have had for savings
There’s an emergency – now what?
- Car accident
- Burst geyser
- Medical bills not covered by your medical aid
No matter how many loans you are paying off, it is important to build up an emergency savings pool. Without access to emergency savings we may be forced to access short term loans through use of credit cards, personal loans, etc. Thereby continuing the cycle.
The rule of thumb is about three months’ worth of your monthly expenses. This is something that needs to be built up over time.
Pay off your mortgage or save for retirement?
Your home loan is long-term debt. Many delay saving in order to pay off their mortgage, but does this make financial sense? Interest rates on this debt are lower than the growth on investments savings.
Imagine, your bond repayment is 9% and your investment is delivering 11% growth. That additional 2% compounded over time will make a huge impact on your final lump sum.
The problem with delaying retirement savings or cashing in your retirement fund early to settle your mortgage, is that you would have to double your retirement contributions to make up for the loss of compound growth over ten years. The general rule is to budget 15% of your income for retirement savings. However, if you delayed saving 15%, that figure would eventually double to 30% of your salary. This is unaffordable for most of us.
Food for thought:
- If you invested R5 000 per month into a fund with an average return of 11% per annum, after 20 years you would have saved just over R4 million.
- If you paid the R5 000 into a mortgage with a 9% interest rate, you would have paid off R555 725 of mortgage debt over 20 years.
Source: Phillip Kassel for Liberty Life