If you’re fortunate enough to be meeting your bond obligations every month with some extra cash to spare, you’re likely wondering how best to invest the surplus funds in a way to make the most out of this money.
If you were to consult a financial expert, he or she would probably rattle off a list of various investment options, with varying levels of risk and return on your investment.
Some of these options may very well yield considerable returns, yet as Van Zyl Botha, FinFive Director has said: “why look to diversify your portfolio when the best possible investment you could make is in your existing bond?”
When faced with an unexpected financial windfall or extra monthly income, most of us would probably find investing in an investment solution other than a bond rather tantalizing.
But the fact of the matter is that any extra capital invested into your bond, in the long run, will far exceed the return on investment you would get by investing your money somewhere else.
When one pays off a bond, one is basically paying off two loans every month. The first loan being paid off is the initial capital amount, whereas the second loan being paid off is the interest charged over the period.
Let’s take a hypothetical case study to illustrate these principles:
Mr. Smith has taken out a bond of R3 million, with an average interest rate of 10%. His monthly installment works out to be about R29 000. Mr. Smith is in fact paying R25 000 towards the interest charged with only the remaining R4 000 actually going towards repaying his bond.
Essentially, over an approximate 20-year period, the total interest that Mr. Smith would pay the bank works out to be the same as, if not more than the initial cost of his house. Mr. Smith will land up paying the bank so much because of something that Albert Einstein is said to have called “the 8th wonder of the world”, namely compound interest.
Over the loan repayment period in this case study, Mr. Smith will actually end up paying about R6 million. However, by putting any extra funds that he has (such as the windfall or extra monthly income mentioned earlier) into his bond, Mr. Smith can greatly reduce this total amount.
By allocating a little extra cash to his bond repayments every month, Mr. Smith will actually save significantly more than he would have earned by investing this money elsewhere.
Let’s further investigate this case study:
If Mr. Smith increased his monthly bond repayments by 10%, he could reduce the repayment period from 20 years to just 16. This means that he would save 4 years of bond payments as well as the interest.
To get this same rate of return guaranteed through an alternate investment or savings vehicle is quite frankly not feasible.
Simply put, no other type of investment can promise to deliver this level of return over a 20-year period. Even an asset class typically associated with high rates of returns, such as stocks, tends only to yield about 4-6% returns annually. And with this sort of investment, there’s the added issue of considerable risk.
Having said that, property is relatively free of risk. Property prices generally increase year-on-year at a rate of about 6%.
Even in today’s economic climate of seemingly endless global financial crises, the property market has shown itself to be relatively stable and capable of weathering the storms of fluctuating market conditions.
moneysmart tip: When applying for a bond with your bank, negotiate a fixed interest rate. This will ensure that your monthly repayments will remain unchanged over the repayment term. Moreover, prioritise your bond repayments. It’s the most significant step you can take to achieving greater financial rewards in the long run.[gravityform id=”8″ name=”Home Loan”]