Should debt be your only

CityPress - - Business - How to use a wind­fall each year to grow wealth R10 000 R20 000 R10 000 R20 000 R100 000 R200 000 R100 000 R200 000 R151 278 R302 555 R151 278 R302 555 R73 439 R146 878 π Net taxed growth rate of 10% R8 096 R16 192 R159 374 R318 747

Con­ven­tional wis­dom sug­gests that you should use a wind­fall such as an an­nual bonus to set­tle your out­stand­ing debt. The ar­gu­ment is that the in­ter­est paid on short-term debt tends to be higher than what one could earn in in­vest­ment re­turns. The prob­lem is that if we con­tin­u­ally use our wind­falls to pay for past ex­pen­di­ture, we never reach a point where we are ac­cu­mu­lat­ing as­sets.

Too of­ten, we use a wind­fall to set­tle credit card or store card debt, and then start the cy­cle all over again in Jan­uary by go­ing back into debt. Think about it. What hap­pened to your last bonus? How quickly did you use that and can you even ac­count for it or show a real ben­e­fit to­day?

When it comes to ac­cu­mu­lat­ing wealth, time re­ally is money as the com­pound­ing ef­fect grows our money ex­po­nen­tially. For ex­am­ple, if the in­vest­ment has an an­nual re­turn of 10% a year, your money dou­bles ev­ery seven years – R10 000 dou­bles to R20 000, which then dou­bles again to R40 000. This is what is meant by ex­po­nen­tial growth. So the longer you are in­vested, the harder your money is work­ing for you.

An­other rea­son to put money away is so that you can cre­ate a buf­fer against fall­ing back into debt. Many South Africans do not have emer­gency sav­ings, which means that in the case of an emer­gency, when cash is needed, this is of­ten funded by ad­di­tional debt.

Put­ting away some of your bonus into an emer­gency fund is one way to en­sure that you do not per­pet­u­ate the debt cy­cle. Mayur Lod­hia, head of re­tail sav­ings Old Mu­tual, says that while set­tling debt is im­por­tant, it is equally im­por­tant to start sav­ing so that you do not have to rely on debt in the fu­ture. This year, con­sider a dual strat­egy of re­duc­ing debt but also ac­cu­mu­lat­ing wealth. PLAN A: PAY OFF ALL DEBT AND START AN IN­VEST­MENT PLAN f you are able to use your bonus to set­tle your debt in full, at least en­sure that you stay debt-free and use the op­por­tu­nity to start sav­ing for the fu­ture. “If you have enough money to set­tle your debt in full, you would have ad­di­tional cash each month that would have gone to debt re­pay­ments to now al­lo­cate to a tax-free say­ings plan,” says Lod­hia.

For ex­am­ple, if after pay­ing off your debt, you have an ex­tra R500 a month to in­vest, you could put this into a tax-free sav­ing ac­count and ac­cu­mu­late nearly R100 000 in just 10 years. (This pro­jec­tion is based on the in­vest­ment strat­egy of the Old Mu­tual Bal­anced Fund. Th­ese amounts are not guar­an­teed.) For sim­plic­ity’s sake, this pro­jec­tion is based on reg­u­lar pay­ments into one fund only. When in­vest­ing, how­ever, you can al­lo­cate your pay­ments into mul­ti­ple funds, and also make lump sum pay­ments to your plan.

IPLAN B: AL­LO­CATE MONEY BE­TWEEN DEBT RE­PAY­MENT AND IN­VEST­MENTS ay off a por­tion of your debt and use the rest of the cap­i­tal to start your emer­gency fund or con­trib­ute to your re­tire­ment sav­ings. For ex­am­ple, use 50% of your bonus to start an emer­gency fund and 50% to set­tle debt.

“The re­duc­tion in your debt means that your monthly debt re­pay­ments have de­creased. After pay­ing off a por­tion of your debt, con­tinue to make the same rand pay­ment into your debts as this will ac­cel­er­ate your debt re­pay­ments and set­tle your debt sooner,” says Lod­hia.

For ex­am­ple, if you were spend­ing R1 000 a month on debt re­pay­ments and this dropped to R500 be­cause you paid in a lump sum, you could con­tinue to pay R1 000, which means the ex­tra R500 per month goes straight to set­tling the cap­i­tal owed. Once your debt is set­tled, you can use the money that was ser­vic­ing debt to ac­cel­er­ate your in­vest­ment con­tri­bu­tions as per plan A.

PAs­sump­tions: π Mar­ginal tax rate of 41% π Full tax de­duc­tion on con­tri­bu­tions As­sump­tions: π Mar­ginal tax rate of 41% π Term: 10 years π Net taxed growth rate of 10% π Term: 10 years THEUNS KRUGER Graph­ics24

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