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Invest or pay off your bond?

Debt

Invest or pay off your bond?

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An avid Zonotho reader recently asked a question that got us excited about writing this article. Philani asked if it wouldn’t be better to put any extra cash in investments instead of using it to pay off your bond. This was after reading Save yourself 10 years of bond payments. Riveting!

Now we all know the benefits of putting extra money towards your bond. You get to pay off your bond faster, pay less interest and avoid the danger of failing to make payments in the future. Similarly, the benefits of having different investments are already well known. Returns on shares and other investments can be very high – allowing you to accumulate wealth for future generations. These points as valid as they are, can be subjective. In true Zonotho fashion, we ran a very simple model to answer this question in an unbiased manner. The results were fascinating!

Consider a situation where you and your colleague got an R70,000 bonus from your company. Imagine that you both have a home loan with a term of 20 years and a monthly payment of R6,980. The interest on both home loans is 11% per year and there are no other costs. Upon receiving the bonus, you decide to invest the full amount in shares. Your colleague decides to use all the cash to pay down her bond. Both of you continue to pay R6,980 into your bonds.

The effect of the two different decisions is that you get to earn investment returns from day one. Your colleague would able to finish paying her bond in 14 years and 11 months instead of 20 years. This saves her R420,000 worth of future payments. Finishing the bond early allows your colleague to use the R420,000, for investments. Saving R420,000 by paying in R70,000 is impressive. But, the verdict on who made the better decision depends on how the investment market performs.  

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If the return on the investment markets is higher than the 11% bond interest rate then you will be better off at the end of 20 years. At an investment market return of 15%, you will have R1,15m. Yes, that’s right. Your R70,000 grows to R1,15m. Your colleague, on the other hand, ends up with over R622,000 if she invests her future savings. If the return is less than 11% then your colleague will be better off. At an investment market return of 7%, you end up with about R270,000 while your colleague ends up with R511,000. 

Clearly, from the above – the verdict depends on the performance of investment markets. If the return that you earn on the investment is more than the bond interest rate then you are better off. Otherwise, if the return on your investment is less than the interest rate on your bond then you are worse off. The challenge is that we can never know how investment markets will perform in the future. A good compromise might be to use part of your bonus to pay off the bond and invest the rest. This is in contrast to putting all your eggs in one basket- a concept known as diversification.

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Thando

Thando is currently the Group Actuary at Clinix Health Group, having previously served as Actuary in Discovery Limited's R&D Lab. Thando loves tech, design, reading and is very passionate about the development of the African continent. Thando also runs Litmail, a tech startup in the e-communication space. All views expressed are Thando's own and neither reflect nor are influenced by the views of affiliated companies.

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