There are many variables to consider, and the correct answer will unfortunately only be clear the day you retire.
Before you make the decision, consider the following:
Motivators why you may want to settle the bond:
- It feels good (and it is good) to be debt free.
- Bonds are paid with after-tax money. This means that if your bond rate is 11% and you pay taxes at 30% then you can effectively save 15.7% in potential pre-tax earnings. This same effect can be achieved if you then invest your settled bond repayment in a retirement annuity and get the tax break.
- Cash flow is freed up, and that allows you to invest in perhaps another property as a rental property for future passive income or start afresh with a new investment portfolio. Make sure you invest in the most tax-efficient way.
There are probably many more motivators to settle the bond, but I will stick with these three. Perhaps a fourth would be if you are concerned that interest rates are going to run away, but you can then always settle the bond when that happens. Unfortunately, when interest rates do run away property values come down, which will technically make you poorer …
Reasons why you should not draw all your investments and settle your bond:
- You lose the effect and benefit of historical compound interest, and it will take you a long time to regain your withdrawn investment value. This is obviously time-dependent and the longer you have been investing, the longer it will take to regain the value. You also need to consider the impact of capital gains tax when you cash in your investments.
- Don’t fall into the trap where your primary residence is your largest asset the day you retire. Too many people rely on some magic future value that will see them through retirement should they sell their property and scale down to something smaller and cheaper the day they retire. When this does happen it is the exception, not the norm. Many downscaling exercises end up disappointing, especially where smaller properties in security estates are substantially more expensive than anticipated. When this is the scenario the ‘residue’ from the sale is much less than expected. In my view, property that does not provide an income stream should not be considered as an asset as far as investments are concerned. Rental property absolutely, primary residence absolutely not.
- You must create diversified wealth. Over-exposure to any asset class or asset is not ideal. Being fixed-asset rich and cash flow poor creates its own problems when you require emergency funds. As the old saying goes, when times get tough, you cannot eat your house …
The above does not really answer your question, does it? Let me try and be a bit more practical.
Scenarios
In my opinion, there are three scenarios that can justify such drastic action.
Firstly, if you are in a situation where you stand to lose your home due to financial constraints and you cannot sell your property in time, then settle the bond.
Secondly, if this means you can be totally debt-free, and you have at least 25 years left to retirement, and you can, in a disciplined manner, invest aggressively by saving/investing at least 30% of your income up to retirement (minimum 25 years) then consider killing the bond. However, keep at least 12 months of income as emergency reserves. It may mean that you must adopt investment strategies like I mentioned above, i.e. investing in a geared rental property where someone else pays your bond.
Read: Investing in property: The good, bad and the ugly
Be very careful though, get proper advice and understand all the risks involved in such a transaction. Consider the implications of rental defaults, tax, theft, maintenance, and area versus future property valuation. Done properly, it can be very rewarding, but unfortunately there are also many horror stories in the property rental arena.
Thirdly, if you have a very secure source of future income, like being a beneficiary with a vested right in a trust, then settle the bond but adopt an aggressive investment strategy similar to the one I referred to in my previous scenario. Don’t use expected inheritance as a guaranteed source of future income unless you are currently a beneficiary of an estate with a known bequeathment.
My suggestion
I am not sure why you are considering this; there must be some concerns or pressing issues on your side. Hopefully, disappointing returns is not one of them because returns will always improve after bad times. Don’t sell in a down market!
I mentioned in my opening statement that you will only know what the right decision was the day you retire. The reason for my statement is that there are so many variables that need to be considered, and the final outcome will mainly be determined by your current bond amount versus investment value, how long you have until retirement, and what the investment returns will be that you missed out on up to retirement (don’t let bad current returns be the monkey on your back). If they are higher than your historical bond rate, then it would have been the wrong decision. If they were lower than your bond rate then it justifies the consideration. The problem is that you have no idea how this is going to play out.
In my view, 20-year+ investments will outperform 20-year house bond rates.
May I suggest that you ignore the ‘stuff’ that you have no control over and focus on what you know and what you can control?
Consider the following:
- Settle a portion of your bond but keep at least 50% of your current investments. Sell the ones that are “in the money” (ones that have grown).
- Take 50% of future free cash flow and place it in your bond. This should reduce your bond drastically if you can do it in a disciplined manner. No matter how small the contribution, the impact will be huge over time. Check with your bank that the additional contribution goes off against capital and not interest (you never know with the banks …).
- Keep adding to your retirement pool, irrespective of whether it is contributing towards retirement funds or voluntary funds.
- Save some money to spend on yourself. You must enjoy the fruits of your hard labour, irrespective of how small they may be. Save until it’s enough, and then reward yourself by splashing without guilt (if you are going to feel guilty, then don’t do it; rather add it to your bond).
- Aim to have your bond settled at least five years before retirement (preferably 10 years) and aim to accumulate 50% of your wealth in retirement funds and 50% in voluntary funds.
I hope this offered some guidance, albeit small.
Good luck with your decision.
#cash #investments #put #funds #bond
