Why your bond is your best investment

So you are comfortably making your bond payments at the end of every month and 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?

Often financial advisers will likely tell you about a range of investment options with varying levels of risk and they might claim that some might even have the potential to reap significant benefits down the line. But why look to diversify your investment portfolio when the best possible investment you could make is, in fact, in your existing bond?

Yes it is often tempting to invest an additional monthly income into an investment that might seem more exciting than a bond. But 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 it 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 is repaying the capital amount and the second is paying the interest charged over the loan period. Let’s assume you’ve taken out a loan of R3 million, with an average interest rate of 10%, your monthly payment will be approximately be R29 000.

You need to be aware that a huge amount of approximately R25 000 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 what is known as compound interest, a principle by which the interest that you are paying on your investment builds up interest of its own and over the repayment period, you can actually end up paying a total amount of about R6 million. Therefore the above amount can be reduced significantly by investing additional money into your bond.

Interest reduction vs accrual

Although it may seem more appealing to watch an investment accrue interest, dividends or capital growth, you will basically be achieving the same end by paying off your existing interest.  Thus when one takes into account the fact that your bond repayment is paid with post-tax income by making additional payments into your bond, you are looking at a real interest rate of anything up to 17%, a rate of return you are unlikely to find in any other asset class. Therefore by paying a slightly larger capital amount every month to help you to pay off your debt, you will end up saving considerably more than you could hope to earn by investing additional cash elsewhere.

For example, 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 yourself four years’ worth of payments and interest in the process.

Risk-free returns

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

On the other hand, property is fairly 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 while the property market has proven able to withstand fluctuating market conditions relatively well. Thus 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 which will further reduce your financial risk. Therefore one must be sure to exercise caution and seek out a second opinion should your investment prospects seem to be too good to be true.

Save now and spend later

Not only will the investment of additional capital into your bond help reduce your debt more rapidly, but it will also leave you with a significantly larger savings pool to draw upon for further investment down the line. Therefore 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. Thus one need to seriously consider making your bond repayments your immediate investment a priority and you will be sure to reap greater financial rewards in the long term.

By: Randles Attorneys