Monthly Archives: July 2016

Invest or put money into your bond

unduhan-30In this advice column Alexi Coutsoudis from PSG Wealth answers a question from a reader who wants to know what to do with a lump sum investment.

Q: I have R100 000 in a unit trust. At the same time I have an outstanding bond. Would it be better to remove the funds from the Investment and offset part of the home loan?

Advisors are frequently asked this question. This often has more to do with personal risk preference than with economic rationality. To answer this question, however, certain assumptions must be made, and I specifically won’t look at tax to keep the answer succinct.

The rational answer

Let us assume that the interest rate on the bond is at the prime lending rate. That is currently 10.50%

The second assumption we need to make is about what the risk level of the unit trust in question is. A money market unit trust has a very different risk and associated return goal than an equity unit trust.

A low-risk money market or income fund aims to beat inflation and offer a real return of 1% per annum. Thus, if the R100 000 is in an income unit trust only yielding 7% to 8%, it would be rational to secure the higher guaranteed return of 10.5% and transfer the funds into the bond.

However, if the money is in a balanced fund which generally targets a 5% real return, it would be more rational to remain invested as the real return is in excess of the bond interest rate.

It is also important not to fall into the trap of looking at the short-term underperformance of equity linked funds in a time like now and compare this to a resilient prime rate. This may result in the wrong decision to sell out at the wrong time. Every situation is unique and the best course of action is to get advice from a financial advisor who will look at the big picture and your individual circumstances.

The subjective answer

The other way I would advise a client on this is a more subjective approach – the sleep test. Quite simply, what makes you sleep better at night? Would that be a bond balance of R100 000 lower than it is now with no funds invested, or the same outstanding bond balance but R100 000 invested?

The answer will be different for each individual and there are a lot of factors that influence one’s financial decision making such as your view of debt as either toxic or as an enabler. For some people having R100 000 invested offshore, for example, gives them comfort. Therefore, because the economic rationality argument is often such a close contest, considering the subjective approach may help make the final decision easier.

Many people are cash strapped

Mounting financial burdens on consumers has led to a 54% increase in disputed debit order complaints over the past year, says the Ombudsman for Banking Services Clive Pillay.

“It is a worrying sign that so many people are cash-strapped and that so many people are over-indebted,” said Pillay.

According to data from the Payments Association of South Africa (Pasa), around 31 million debit orders amounting to R72 billion are processed per month, of which 1.2 million are unpaid and a further 170 000 are disputed.

There are two categories of debit orders: EFT debit orders, which are processed on the date chosen by consumers and mostly after normal business hours, and early debit orders, which are collected shortly after midnight and immediately after the processing of EFT credit payments such as salary payments, explained Pillay.

He said several complaints lodged with his office centre around non-authenticated early debit orders, whereby transactions are processed prior to the agreed date. Pasa data show that almost 14 million non-authenticated early debt orders worth R9 billion are processed each month, 4 million of which are unsuccessful, with 600 000 disputed.

An estimated 90% of disputed debit orders are for so-called ‘cash management’ reasons, Pillay said, citing Pasa data. “The Payments Association investigates every disputed debit order and often they are legitimate disputes, but there are also ones that are not legitimately stopped. They are done simply because you have to pay five people but you only have money to pay four, so you stop one debit order and then double it up the following month,” he said.

Dishonouring debit order commitments for cash management reasons is considered unethical or fraudulent. Failure to pay debit orders on time or within the 15-day grace period, can result in penalty charges and even the cancellation of contracts. The cancellation of an insurance policy would result in no coverage in the event or a loss and no refunds of premiums can be claimed.

Consumers struggling to meet their financial commitments should approach their banks for assistance, advised Pillay.

The Code of Banking Practice commits banks to assist clients in dealing with financial difficulties. As such, banks are obliged to review their clients’ financial situation with the said clients and develop a plan to address any financial difficulties. Such a plan may include a so-called ‘payment holiday’, whereby certain payments are suspended for a three-month period, a temporary reduction in instalments or halting of interest payments, he said.

He added that such informal assistance would not lead to clients being blacklisted or being listed as a bad risk with various credit bureaus, which will have a negative impact on the client’s ability to access credit in the future.

“Access to finance is the lifeblood of industry and the individual. Without access to finance, you will be reduced to a cash existence and, if reduced to a cash existence, you will probably have a low quality of life,” he said.

Investment in the short term

In this advice column Kirsty Scully from Core Wealth answers a question from a reader who wants to know what to do with a lump sum investment.

Q: I’ve decided to sell my house, and I expect to realise just under R1 million. I would like to use this money to pay off our debts like our credit cards and possibly our cars. That will leave me with approximately R500 000.

My plan is not to buy another house just yet as we are not sure if we may move to a different province or even different country in the next couple of years. With all that is going on in the markets and considering that all of my other money is either in exchange-traded funds (ETFs), unit trusts, retirement annuities and another property that I own, would it be wise to invest my money in physical gold? Or would it be better to invest in a money market account where I can get 6.4%?

I want something safe, as it is not often in life you get a lump sum like this. We are also sacrificing having a nice big house in order to live in a smaller dwelling for the sake of being prudent and using this opportunity wisely.

As with many similar questions that I have been asked over the years, it is vital that you meet with a financial planner. A full understanding of your financial situation is required. It is not wise to give recommendations based on only a portion of your investment information.

However, that said, let’s assume that I have understood your risk profile accurately, and that a ‘couple of years’ refers to two years. I would consider the following to be wise counsel:

It is unlikely that allocating the full amount to gold would be appropriate as the price of gold can be volatile over short-term periods. I would also assume that the lump sum of R500 000 is unlikely to be a small portion (i.e. less than 5%) of your overall portfolio, and this makes it even less appropriate to allocate the full amount to gold.

In addition, you specifically ask about physical gold, which in most cases is Krugerrands. When investing in Krugerrands there are fees of about R3 000 per ounce (you can buy for R21 000 versus selling for R18 000 as per the Cape Gold Coin Exchange), which need to be taken into account. Over a short-term horizon, these costs could be really punitive.

The gold price would therefore have to increase substantially over your two year period to beat the 6.4% per annum offered by your money market option. Remember you will also have to take into account the storage and insurance costs of holding physical gold. Therefore, taking all things into consideration, I would consider gold to be a relatively high risk investment for you.

The money market is probably one of your safest options. However, I am interested that you quote an interest rate of 6.4%, as I know other options that offer up to 8.0% per annum. Make sure that you do your homework well, in conjunction with your financial planner. You may even look at the possibility of a 24 month fixed deposit, where the interest offered is currently about 8.8%.

Depending on your marginal tax rate and your age, a more efficient investment may well be through a dividend income-type of portfolio. Ask your financial planner about this because you should be able to achieve an improved growth rate after tax compared to a money market. All in all, this will still be the relatively low risk that you require in a two year, short-term investment.