The standard advice you are likely to hear in investment circles is to get rid of your debts first before you think about saving and investing. This is because interest payments tend to chew up funds faster than your money can grow in a bank account or investment vehicle. But, as independent financial advisor Dawn Ridler highlights here, it’s not realistic for most of us to fully pay off our debt. What’s more, it makes sense to have access to debt so that you can cope with the unexpected – like interest rates suddenly soaring. In this piece, Johannesburg-based Ridler shares how to “look after number one” by harnessing debt and using credit to your advantage. She advocates investing while you are wiping out bad debts, like the budget facility on your credit card, so that your wealth building plans have time to take shape. She sets out six steps you can take to clean up your money act and shares practical ideas on how you can work on your personal finances so that they are fighting fit when you are ready to retire. – Jackie Cameron
By Dawn Ridler*
One of the most common questions I am asked is “Should I pay off my debt or Invest?” Logically, the answer is simple, pay off expensive debt before you invest, but this doesn’t take human behaviour into account and in the long term can result in someone ending up with no investments
Why? Debt has a habit of being continually paid down and built up again, despite the best of intentions. So basically, unless you have never built up debt again having paid it down, invest anyway. This blog will give you one way to do that – sensibly.
In this uncertain world, you have to look after number one – you and your family. Keeping yourself ‘liquid’ is a very smart move. We are quick to forget a short nine years ago when the credit crisis really hit and banks stopped lending money – to anyone. Even “access bond” accounts were frozen. Going even further back into the 90s, interest rates went over 20%, doubling and tripling bond repayments. How would you fare if that happened again?
You’ve probably heard the phrase ‘pay yourself first’ numerous times – but what does that really mean? Does it mean you invest and your creditors must wait? No. It’s important to preserve your credit rating (some employers look at this too.) It means that you put yourself in the position that you get rid of the albatrosses around your neck, and gradually take back their share of your pie.
Cleaning up your act so that every month you put something into investment is a phased approach. It’s like all good intentions, if you want the habit to stick, you start to do something PHYSICALLY – but you don’t go all out or you – and your goal – will burn out. This is why I like the step-by-step approach. Putting your money on ‘diet’ is like going on diet to lose weight, you can’t go ‘cold turkey’ – money has to be spent on necessities and food has to be eaten so you don’t die – but you’re not going to die if you stop smoking, drinking or spending on luxuries – even if it feels like you might.
Step 1: You need to know your present status in broad terms – what your ‘liquidity’ looks like. In other words how much money you have left after all the fixed and regular payments have come off, including your credit card payment (irrespective if it was in full or partial) from the previous months. If there is nothing or you’re going deeper into debt every month, you have little option but to dig deep into those expenses and find out what or who is poking holes in your wealth bucket. The lowest hanging fruit is day-to-day expenses. You have to break the cycle and find the best way to do it – for you. If you’re this far down the hole, you need to stop digging. Take out the cash needed for the bare minimum of day-to-day expenses and don’t touch your bank account or cards for a month or two. This ‘cash diet’ can break unhealthy habits pretty quickly.
Step 2: Find out what your day-to-day expenses are for the month, for the whole family. If you’re just paying the minimum on your credit card every month and paying them off in full is going to put you into the red, then this is the first thing to clean-up. Why? For a start, you’re paying interest of 18-22%. Finding your disposable income does not have to be a long-winded or detailed budgeting exercise. More often than not that will leave you frustrated and disheartened. A quick flip through your bank statements with a highlighter will give you your fixed and regular expenses. Putting all other expenses on a credit card can simplify that too (taking advantage of no swipe fees and interest-free if paid off before due date)… But. There always is a ‘but’ isn’t there? Cap that card at the daily monthly necessities – one phone call to the bank will achieve that. You can do this ‘budgeting’ exercise manually or by using an app like 22seven (free from all app stores). There is no need to spend hours with a complicated budget spreadsheet and inputting all the data. That done, you should now have ‘what’s left’ or your ‘disposable income’.
Step 3: If you have a credit card that you’re rolling over every month and not paying in full, put some numbers together on how you’re going to kill that debt. Take the minimum this month and work out how long it will take to pay it off – at that rate (factor in the interest). Put half of your disposable income to this and set up a scheduled payment to make this happen. Most banks will let you do this online – if it doesn’t perhaps it’s time to find a bank that makes it easy for you to manage your money on your own time. Put that credit card out of harm’s way – give it to a friend or freeze it (literally). If you can’t cap a card to daily expenses, you may need to open a new one (a low-cost platform like Capitec for example).
Step 4: Now that you have a card/s that are capped to your budgeted day-to-day expenses, put the other half of your disposable income into your emergency fund – a savings pocket at your bank will do. Your emergency fund should have 3 times family income after tax (before deductions like pension and medical aid). While it might make sense to use investments to pay off debt, if you’re relationship with debt hasn’t been great, rather leave it – you might just need it. Never cash in your pension fund when leaving a company – for anything! Not to pay off debt, not to pay into the bond and not to start a business.
Step 5: So… Your credit cards, personal loans and overdraft are history and your emergency fund is now at least at one month’s family expenses. NOW you can look at actually investing properly. Do you know (in ‘present value’ terms) how much you need to retire, at the age you want to, and how much you need to put away every month to achieve this? If not, do this exercise or ask your advisor to help you with it. Now split your disposable income between your emergency fund, and put the rest into your ideal retirement contribution (the tax deductions max out at R350k or 27.5% of your income but all your retirement income need not be in retirement funds, they just need to be there.)
Step 6: Your emergency fund is full and you’re contributing the ideal retirement savings amount – now what? Kill the car debt (and never have it again – cars ideally should only be replaced every 10 years or so. They are not an investment). Put those repayments you would have been making into a “Capital replacement” fund for when you need to get another car or move house. Moving house can cost up to 15% of its value, if you don’t want to increase your debt, then best have this as ‘cash’. Next – the mortgage. It may be a good idea to bring this right down but not kill it completely. Why? It is one of the cheapest forms of finance (10.5%) and one way to start a rental property portfolio. Ideally, a rental property should have its own mortgage, but because you don’t have to go through the process (and expense) of getting another bond it is a good way to start it. Structured correctly, (in a company, or even in a company in a Trust,) the funds used for the rental property would form part of your (interest bearing) loan account and would be deductible off tax. When you ask for ‘new’ credit for a rental property they will take the FULL possible credit line into account and not what the bond is now, which is why you may not be granted another bond, even if you can afford it. Even if you don’t want to go the rental property route, keeping the bond open at a minimal amount will give you the financial agility to move in on an opportunity. Speak to your investment or financial advisor when you get to this stage so that you optimise your portfolio and take advantage of the tax deductions and align the investments with your future objectives.
Action: Procrastination is the thief of your wealth, we all know that but do it anyway. How can we break this inertia? The most proven way is to act immediately you decide you want to do something, and I mean immediately, take some physical steps to get started. When it comes to finance, most of that can be done from whatever device you’re reading this on. Download the app, open the savings pocket, set up scheduled payments, look hard at your statement, find out where you’re wasting. Don’t think about doing it, do it.
- This article is published here on BizNews.com with the kind permission of Dawn Ridler. Ridler is an Independent Financial Advisor with extensive experience in both financial advisory and business.