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Friday, 27 July 2012

WITH INTEREST RATES AT RECORD LOWS, IS IT WISE TO BORROW TO INVEST NOW FOR RETIREMENT?


Traditional investment & retirement advice suggest that one should invest 10 to 15 percent of one’s income. At its most basic, investing is about putting your money to work. If you have a R100 note and you leave it under your mattress, nothing much will happen to it.

If you put it in the bank, it will earn a bit of interest, but not nearly enough because inflation will reduce the value of your money over time. Yesterday SARB Governor Gill Marcus announced a surprising drop in interest rates by 50 basis points (0.5%). This is the lowest it’s been since 1973! The sad news is even though it brings much relief to us homeowners and struggling consumers in the short term, every drop in interest rates impacts heavily on the pensioners and savers. Once again the Pensioners & Savers end up the losers! Unfortunately we can’t have it both ways.

However, if you were saving money eg: R100 a month & you took that R100 and use it to buy shares in a promising company, in years to come it will (hopefully, if you picked the right company) be worth more and more, and it will also deliver a valuable stream of income in the form of dividends, which you can use to buy even more shares. If you invest wisely, the growth you’ll see from your R100 will be enough to stave off the effects of inflation and to increase the real (inflation-adjusted) value of your initial investment and that, in a nutshell, is how you build wealth.

With interest rates so low it could be wise to implement a savings plan now IF you can afford toborrow wisely at low interest rates. If you borrow smartly and invest wisely you could most likely end up financially free in the years to come. People borrow money to buy houses, so why not shares ? Of course you can LIVE in a house, regardless of its market value BUT you can’t live in a stock portfolio.  That’s the reason why many people out there are afraid to risk borrowing money. In reality many people use credit and debt to purchase liabilities. If you change your mindset about debt and use debt wisely it could be very rewarding.

Usually how one decides ones exposure to build a portfolio of shares would be to take the number 100 less your current age. A 25-year-old might want their portfolio to be 75 % exposed in shares for example. A 60 year-old might decide to be 40% exposed in shares . The problem with this advice, is that 20-year-olds haven’t saved much yet.
Although a 60-year-old has reduced percentage of his portfolio exposed to shares , he has more money exposed to risk – & at that age is least able to recover from a wipe-out should the markets sink. Conversely, the 25-year-old may have 75% or even 100 % of their portfolio in shares or ETFs funds. But that’s only a small amount and should markets fall they will be able to recover faster because they still young.

Example: Jill is 25. She only has R25,000 saved for retirement. 90% percent of that, or R22 500, is invested in shares. Jack is 60. During the past 40 years, he’s amassed a retirement portfolio of R680,000. Half of that, or R340,000, is invested in shares & ETF’s. When the market drops 3%, Jill loses R675. Jack loses R10,200.
The solution?  If you young and responsible with using money, it could be wise that you borrow money now (while ‘cheap’ credit is available) to invest early in your retirement account.

Why do I say so. Assume you had R20,000 in credit card debt at 18%. If you had the R20,000 now to pay off the credit card debt, would you or would you invest the money instead?
If you could earn much more than the 18% you were paying on the credit card wouldn't paying it off be a silly thing to do? It’s an emotional decision to make. Ask yourself which number is greater; the return on your investment or the interest you are paying. If you are paying more interest than you could earn, you are far better off by paying down the debt.

For example, assume you owe R20,000 on a credit card. Say you actually have R20,000 in the bank which you could use to get out of debt completely. The credit card interest rate is 18% and the bank is paying you 6%. At first, this seems like a no brainer. I would pay off the credit card. Well, not quite. Assume you also have an opportunity to invest R20,000 in a business earning 25-30%. Now, the choice becomes more complicated. If you pay off the credit card, you are making a guaranteed 6% because that’s money that you’ll keep in your bank account rather than send off to Visa or Mastercard.

If you invest in the business, you are guaranteed nothing. You might earn 25-30% – or more. But you could also lose everything. So which is greater? A guaranteed 6% or a possible 25-30%? The only way to approach this is to estimate the likelihood of earning that 25-30%. If the chances are high, you might go for it. If not, you might pass on the opportunity. From a financial stand point, you have to consider the cost of the debt especially in the current financial climate. Beyond financial considerations, there are also the emotional points. How would you feel if you paid off the debt? How would you feel if you don’t invest? How would you feel if the investment doesn’t work out?

These are important as the financial questions. What good is it to make an otherwise smart financial decision if at the end of the day you are left feeling miserable? In most cases. At the end of the day its your solid decision to address both the financial and the emotional issues and where you want to be financially in the future. Like I always believed, If you want to predict a person’s financial future, look no further than their expense column. Are they buying liabilities or assets? Are they buying good debt or bad debt.

what would you do?

**The views expressed in this Note are those of my own and should not in any way be regarded as Investment advice.**

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