Why Your Bond is Your Best Investment

Why Your Bond is Your Best Investment

Private Property South Africa

FinFive director, Van Zyl Botha explains why you needn't look further than your existing bond for a good investment opportunity. So you're comfortably making your bond payments at the end of every month and are looking for a sensible way to invest your surplus capital. What is the next step in making your hard-earned money work best for you?

Financial advisors will likely run you through a range of investment options with varying levels of risk and yield, some of which might have the potential to reap significant benefits down the line.

Yet, why look to diversify your investment portfolio when the best possible investment you could make is, in fact, in your existing bond? It is often tempting to invest an unforeseen windfall or additional monthly income into an investment class that might seem more exciting than a bond. The amount you'll save by investing any excess capital into your bond will, in the long term, far outweigh the rate of return you could hope to achieve by investing elsewhere.

What does this really mean?

Paying off two loans

When you take out a bond, you are essentially paying off two loans every month - the first to repay the capital amount, and the second to pay off the interest charged over the loan period. Assuming you've taken out a loan of R3 million, with an average interest rate of 10%, your monthly payment will be approximately R29 000. You need to be aware that a massive R25 000 chunk of this will go towards paying off the interest, with only the remainder actually being used to repay your bond.

This means that the total cost of the interest you pay back to the bank over a 20-year period will in fact equal, or even exceed, the original cost of your house. This is due to a phenomenon known as compound interest, a principle by which the interest that you are paying on your investment accrues interest of its own. Over the repayment period, you'll end up paying a total amount in the region of R6 million. This sum can be reduced significantly by investing additional money into your bond.

Interest reduction vs. accrual

Whilst it may seem more appealing to watch an investment accrue interest, dividends or capital growth, you are essentially achieving the same end by paying off your existing interest. When taking into account the fact that your bond repayment is paid with post-tax income, you're looking at a real interest rate of anywhere up to 17% (factoring in your earnings prior to taxation) - a rate of return you'd be very unlikely to find in any other asset class.

Simply put, by apportioning slightly more capital every month to help you to pay off your investment, you'll end up saving significantly more than you could hope to earn by investing additional cash elsewhere.

For instance, by increasing your monthly bond repayments by just 10% on a R3 million loan, you could end up paying off your 20-year bond in just 16 years, saving four years' worth of payments and interest in the process. To achieve the same rate of positive return via an investment in a JSE traded company or a money market account on a guaranteed basis is simply not possible.

Risk-free returns

There isn't any other investment that can guarantee you this type of return over the course of 20 years. Even high-yield asset classes like stocks only tend to produce a 4-6% annual dividend; even then there is significant risk associated with the investment.

On the other hand, property is relatively risk-free, with prices tending to increase year-on-year in the region of 6%. In uncertain economic conditions, the financial prospects for a company can rapidly deteriorate, whilst the property market has proven able to withstand fluctuating market conditions relatively well. By negotiating a fixed interest rate with your bank, you will be able to ensure that your monthly amounts remain unchanged over the course of your repayment period, thereby further reducing your financial risk.

If your broker is able to guarantee you an equal rate of return for an alternative investment over a 20-year period, it's likely to be in the form of a pyramid scheme, so be sure to exercise caution and seek out a second opinion should investment prospects seem to be too good to be true.

Save now, spend later

Not only will the investment of additional capital into your bond help you to eradicate your debt more rapidly, but will also leave you with a significantly larger savings pool from which to draw upon for further investment down the line.

By paying off your bond faster you will be afforded a far stronger financial foothold, and be able to accrue real profit from a diversified investment portfolio at a later stage. Make your bond repayments your immediate investment priority, and you'll be sure to reap greater financial rewards in the long term.

*Taken from Bizcommunity with permision from FinFive


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