Should I rather pay off my bond than into my RA? – Moneyweb.co.za

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Investor question:

Due to poor market performance, the monthly fund value on my retirement annuity keeps decreasing despite the constant addition of my monthly contributions. I’ve queried this with the administrator of my RA and they dismissed this trend as a “small drop in market value due to market movement as well as the monthly asset fees which were deducted.” The administrator has also stated that since I pay 41% as an income tax-payer, I have reached the full tax-benefits received by contributing to an RA.

My question is simple, would it not be more advantageous for me to put my monthly contribution of R26, 000 into my Mortgage Access Bond for the foreseeable future? I currently owe R850 000 on my house & my monthly mortgage payment is approximately R12, 500. I hope to retire in 2 years (age 64) so a mortgage payment of R 38 500, for even a year of the two, would make a huge difference in reducing my bond liability before I retire. I would then convert my RA fund into a Living Annuity. If the market returns become positive again, I can then withdraw that accumulated amount & pay it back into my RA?

Response to investor question:

Dear investor, let me start off by saying this is not a simple question as stated above. Your question has many facets to it so I’ll answer it in separate pieces.

Managing my expectation in a low return market

For South African investors, the last couple of years have been tough and frustrating. When you look back at all your investment efforts, it certainly has been more of a case of consolidation rather than growth. At times, it has felt as if as an investor you’re running frantically just to stand still. I don’t know what your current investment or asset allocation is but what I will say is the market has moved sideways rather than down, in Rand terms, over the last few years. The picture is abit bleaker if you assess our market in Dollar terms.

One of the key responsibilities of a financial advisor is to manage their client’s expectations as far as investment returns, and then to help them implement investment strategies consistent with these return expectations and their risk tolerance. Are you working with an advisor? If so, are they guiding you appropriately? It doesn’t sound like it. Are you managing the funds yourself? If so, do you have the investment skills to do so? It’s human nature to extrapolate recent behaviour into the future. We have been told time and time again to separate emotions from rational investment decisions, but that is far easier said than done. Let’s look at the market performance objectively.

As at the close of market on Friday 23 June 2017, the different asset classes have performed as below over the last year: 

  • SA Equity Market (ALSI) has lost 1.1%, led by Financials which are down 3%, Resources down 1.1% and industrials down 0.3%.
  • SA Listed Property has managed to generate 4.4%,
  • The real winner has been SA Bonds which have returned a solid 10.1%!

A large portion of the above performance can be attributed to currency movement, the Rand has had a good year and continues to rally and has strengthened 9.8% against the USD over the same period. If we look at the global picture, developed markets seem to have turned the corner over the last year and performance stands as follows: 

  • The US market (S&P 500) is up 15.4%,
  • The UK market (FTSE 100) is up 17.1%,
  • Japan (Nikkei 225) 24.1%
  • This leaving the MSCI World Index up 13.8%!

Who would have thought that through all the “bad news” over the last year, the Brexit saga, Eurozone woes and Trump madness, markets would have rallied?! I make this point to simply state that for your investment value to be constantly decreasing monthly, you either have an extremely poor investment strategy or your problem lies more in the fees charged on your investment. To further support my case, we can look at the publicly published asset class forecasts, comparing the previous 10- year annual average returns vs. the forecasted returns for the next 10 years: 

  • Local equity 10.6% p.a. vs the next 10-year forecast at 8-12% p.a.
  • Global equity has returned 9.5% vs 8-12% expected.
  • Local property 14.2% vs 9- 12%
  • Local bond 8.1% vs 8/9%%
  • Local cash 7.4% vs 7-8%
  • Inflation 6.4% vs 6-7%

In periods of low expected returns or even when a correction looks eminent, investment selection is even more crucial. Within your target asset allocation are you positioned in the best investment vehicles possible? If index funds are being used are they in the lowest cost versions available? Are they in institutional share classes (or similar) for actively managed funds? Are there funds on your watch list pending action? Times are tough but the market isn’t crashing, at least not yet. Without knowing more about your case, I’d guess and say your biggest problem is the fees you’re paying. Fees can compound the negative effects of being in a low-growth market.

What effect do fees have on my investment?

There’s a common saying that says you have to spend money to make money. This is not one of those instances. Don’t let high costs eat away your returns. Yes, all investments have costs even if you don’t realise you’re paying them, but any fee charged on an investment account must be justifiable and in your best interest. The money you pay to invest has a big effect on what you have left in your own pocket. Investments with higher costs must overcome these expenses, thus their performance tends to suffer vs. lower-cost investments. Higher price doesn’t automatically equate higher quality. Sometimes you’re just being ripped off.

Investment costs might not seem like a big deal, but they add up, compounding along with your investment returns. In other words, you don’t just lose the tiny amount of fees you pay—you also lose all the growth that money might have had for years into the future. This is before we even consider the erosive effects of inflation. The body of research on fees is large and clear-cut: investors can cut portfolio costs and increase returns if they are vigilant in their choices.

What matters most when investing is the amount of money you keep over time after fees and accounting for inflation. Whether one is investing a lump-sum amount or a series of periodic amounts, the arithmetic of investment fees is compelling. In the words of William F. Sharpe, a Nobel Prize winner in economic science, “Wealth erosion is most severe when you subtract less visible costs, like holding onto cash or portfolio turnover.” There’s enough already against you in the world of investing, it is brutally difficult to beat the market after taxes, inflation and expenses, so be very vigilant on the fees you pay.

What tax benefit does a RA provide a high-income earner?

The tax harmonisation of retirement funds has seen the introduction of a cap of R350 000 per annum on deductible contributions to pension funds, provident funds and retirement annuities as of 1 March 2016. This was not great news for a few high net worth individuals (HNWIs) who previously contributed in excess of R350 000 to retirement vehicles and who were able to deduct the full contribution from their taxable income. Capping the deductible portion of their contribution at R350 000 had a knock-on effect of decreasing their take-home pay. I assume you were one of these HNWI, people who earn more than R1.27 million per year and who contribute 27.5% or more of their remuneration to a retirement vehicle.

I assume you’ve had to make some tough choices. Do you continue to contribute the same amount or explore other investment options? From your question though, your annual contribution is R312, 000 so there is still some benefit to be derived from contributing to an RA. Ultimately that decision depends on your personal circumstances. Have you considered a tax-free investment? These accounts currently cap annual contributions at R30 000, which will likely be small change for a HNWI, but it’s a start. Very few retail investments over long investment periods, can offer the convenience and value of retirement contributions, even though it may not be as tax efficient as it previously was. The contributions and growth are protected against creditors, reduce tax-liability and remain tax-free within the retirement vehicle. It’s important to also note that the un-deducted portion of your over-contributions to a retirement fund is carried forward to the next year and eventually paid to you in the form of a tax-free pension, thus keeping the money in the retirement fund also helps to derive some benefit in future.

Should I contribute to my RA or pay off my mortgage bond?

This question highlights the importance of a holistic approach to your personal finances. The danger of putting all your contribution efforts into your home is that although you will have a roof over your head, you will have a decreased retirement maturity value, a reduced income post-retirement and an inability, or reduced ability, to maintain your current or desired standard of living. You need to follow a holistic approach that both reduces your debt and builds up growth assets.

That being said…. Being bond free is probably one of life’s sweetest pleasures. Should you get there, this a major expense you can scratch off your budget, and will put you in a league above most people. The reality in South Africa is that most people can’t even qualify for a bond, those that do rarely are able to pay it off due to them living above their means and thus focusing on too many “upgrades” during their lifetime, as opposed to servicing and eliminating debt. The next thing I want to say is that paying off debt is always a good idea, there is no two ways about it. Let’s look at the advantages of paying extra into your bond: –

  • It is risk free – the money you put in cannot be wiped out
  • It is tax free – one of the few things in life that is!
  • It is inflation beating – if the interest rate is above inflation (as far as I know this has always been the case in South Africa)
  • Low cost – there are no extra fees involved (your bond fee is charged regardless)
  • Highly liquid – you can always take the money out again if you need

Given the period stated in your question, 2 years, and the outlook on market performance over that period, I would say that paying extra into your home loan is definitely a great idea! In the short term, the interest saving on your bond will probably be higher than the return earned on your RA, especially with your current administrator, fees and investment strategy. I say this not having done a full financial needs-analysis so this is just my personal opinion and should not be taken as advice in accordance with the FAIS Act (37 of 2002). Your question would require a very lengthy explanation/comparison on the risk and return expectations of different asset classes and investment products, which is beyond the scope of this forum. I’ll end of by stating the following: –

  • If you want to lower the financial risk in your life, you should reduce your exposure to debt (i.e. your bond).
  • If you want to provide adequately for your retirement, then keep investing in your RA, but make sure you are invested according to your investment time horizon.
  • Never try time the market. It really is a futile attempt. No human in all investment history has ever done it with any prolonged, consistent, measurable and repeatable success. The plan to return when things turn for the better is a shaky plan at best.

I hope I’ve provided some insight and value with my answer. Speak to a wealth-manager, do a full financial needs-analysis and get a personalised answer.

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