1. Ignorance,
2. Indulgence, or
3. Poor Planning

Debt is often the symptom of some “other” issues but that is the subject for another post. In this post I want to look at the first category: ignorance. This is where someone has no idea of the real cost of the debt. For example, few people stop to think that the total cost of all the interest payments on a million rand house over 20 years is over R2.3million rand – R1.3million of that is interest!*

The National Credit Act has made it a lot easier for people to know the full cost of a financed purchase as the total cost of the item being purchased has to be displayed. This includes the interest, finance charges and even insurance charges. So if you are buying a car and financing it, you must be shown the full costs of financing it over the period for which you have opted and even advertisments are supposed to show this information (take a closer look next time you see one).

But one of the areas that has fallen through the cracks is the cost of having debt while trying to save at the same time. Consider the following fairly typical example:

• Client A has a current account which is in overdraft of R7000. At the same time he has R11000 in a bank savings account just to see himself through any financial emergencies.

While the principle of an emergency fund is an excellent one, what he has not realised is the cost of keeping money in it while he is in overdraft.

Typically banks now charge a monthly fee for the “privilege” of having an overdraft facility on your account. One bank that I contacted today charges R57 per month for this (that’s R684 per year!). At the same time they levy an interest rate of 16% per annum on overdrawn accounts. On R7000 that amounts to R1120 per year – so the total cost of the overdraft is R1804 per annum.

Now at the same time, the positive interest that they pay on R11000 in a savings account is 0.25%, or R27.50 per year (this is criminal). So the real cost of this financial compartmentalization is R1776 per year! Of course the bank know that the client is wasting money and if you ask them, the would probably advise against doing this kind of thing but then again, if you dont ask, they make more money and that’s what they are there for.

So my advice is to use the money in the savings account to pay off the overdraft and then use the money you were paying into the overdraft to build up the savings account again. And better still, use a money market unit trust account instead of a bank savings product – you will get about 6.5% interest per annum (Capitec bank offer 7% on balances under R10000).

* interest rate of 10% per annum.

Related posts:

1. Look after the small things…
2. The real cost of the bond…
3. Thanks to the regulators!

Related posts:

1. Best interest rate?
2. RSA Retail Bonds part 2
3. Ignorance is not bliss!

Here is my thinking…

Following some basic maths, I calculated that the projected return using Fundisa would look something like this (assuming R200 from me + R50 from govt and a 10% per annum return – this also assumes no escalation on the contribution because the bonus is capped on the first R200).

So after 10 years there should be ±R51000 in the account and by 15 years, ±R103600…

However, if I use a simple balanced fund and I put away R200pm, no escalation and I can get a return of 14% pa (which is the historical average return for this sector over 10 years) the results look something like this:

So for the first 9 years or so, Fundisa is a better prospect, however after that, it gets left behind. This is without any escalation on the debit order – which you would normally do and also assumes I use a balanced fund not an equity fund which would be totally appropriate over a 15 year period…

So we have a problem…Given that most people will start saving (via Fundisa) when their kids are very young and will therefore be saving for much more than 15 years, Fundisa is not as good as it appears and anyone using it would be worse off over anything more than a 10 year period…

To my mind, Fundisa needs to do the following to make it a really attractive option:

1.       Fundisa needs to have an alternate (more aggressive) fund option such as a balanced or equity fund.

2.       Fundisa needs to allow for bonuses on an escalation – this could be capped at 10% per annum.

Even if I escalate my contribution on Fundisa without the bonus increasing, I will still be significantly worse off than escalating the contribution on the balanced fund (without any bonus)…

I have written to ASISA re these concerns and will post their reply if we get one…Fundisa is a great concept, but in my opinion, it was not clearly thought through…

For now, I would hold off on new investments into Fundisa.

Related posts:

1. Fundisa – it’s a no-brainer!
2. Guaranteed returns of 25%?
3. RSA Retail Bonds part 2

Turns out though, that if you want to invest via the website you need to “register” and once you have completed the form online, you will be issued with bank account details so that you can make the payment.

We made the recommendation to them that the document is made available and that the “register” button is changed to “invest” or “invest online”…let’s see if anything changes.

While spending some time on their website it is also interesting to see the age profile of investors in the RSA Retail Bonds…±40% of investors are under 50 and almost 22% are under 40 years old.

While there is nothing wrong with investing into the RSA Retail Bond, it is hardly a suitable investment vehicle for a 25, 30 or even 40 year  year old…but I guess that is one of the dangers of “cutting out the advice chain”

Investors may have got into the product without paying commission but a 25-40 year old investor sitting in the RSA Retail Bond is most probably in an inappropriate product…it is certainly not an emergency fund (you cant access it) and the majority of 25-40 year olds are not looking for income from an investment – it is capital growth that they need and for that, there are far more appropriate investment options (even if there are some fees to be paid to advisors).

A typical “balanced fund” unit trust has given returns of almost 15% per annum for the past 10 years. At that rate the money has doubled in value every 5 years while investors in the RSA Retail Bond will only see their funds doubling every 8 years…I know where I would rather be invested!

Related posts:

1. RSA Retail Bonds
2. Interest (ing)…
3. The real cost of the bond…

Well, I have been trying to buy some of these for a “man-in-the-street” using the RSA Retail Bond website – what a nightmare. There is an application form online but no details where to submit it or how to pay the funds into an account.

So I sent an email to the address on the site – 4 days later and still no reply. So I tried calling the telephone number (which is the number investors are supposed to use if they want values) and it just rings and rings and rings until it goes dead…

I know that you can also buy these at Pick n Pay or via the Post Office but if that is the only way to do it then why have forms on the website? And if no-one is going to reply to emails or answer the phone, why have an email address or telephone number on the site? And if you are not going to reply, how do you expect investors to get information or communicate with you?

This is my first experience of using this investment vehicle for a client and so far, I am not impressed.

I have written to the communications manager at National Treasury – let’s see if we get a reply.

Related posts:

1. RSA Retail Bonds part 2
2. Dont get caught!
3. Interest (ing)…

There is an old song where the lyrics went something like this “the chances of anything coming from Mars are a million to one, but still they come!”

At least the odds were better than the chance of you winning the lotto in SA where your odds are one in 13 983 816 (or 0.000000072%)*.

Let’s put this in perspective: if there are 2 draws per week (104 per year) then you would need to play the lotto every draw for 134459 years to have played it ±14 million times and to be reasonably sure that you would win it just once. The slogan used to be “if you’re not in you can’t win” but it if they are honest it should probably be “even if you are in you probably won’t win”!

Now if the average life span is 75 years then the average person will live for 27375 days and then simply put (and not complicating things with actuarial tables) the chance of dying on any given day is 1 in 27375 or 0.000037%. You have a 511 times greater probability of dying on any given day than you do of winning the lotto!

In June 2003 it was reported that 27% of lottery players were unemployed and that 43% of players earned less than R2 000 a month. 2006 research found that 82% of South Africans played the lottery once a week and that 53% of the population did not engage in any other form of gambling. The average player spent R81 per month on the lottery with the lottery accounting for ±26% of total gambling spend in SA. Those who play slots spend R541 per month on average, and slots constitute ±44% of all gambling expenditure in the country.

Research was also conducted into gambling spend by disposable income groups, and this confirmed that all income groups are playing the lottery regularly. 70% of those who are in the lowest income groups (disposable incomes below R1 400 pm) play the lottery regularly.

So if the odds of winning are so ridiculously low why do people still play it? Can you really gamble with your head? The real motivator for playing is that one very, very small chance that you might just win that jackpot which could change your life forever – although this might be in ways you’ve never contemplated. (More than a few lotto winners have died quite soon after winning, either from natural causes or from crime related incidents).

So if the motivation for playing is the ability to change your life once and for all, why not invest that average lotto ticket money? If you took the R81 per month and invested it into a unit trust fund where you got a return of 5% better than inflation then you would end up with ±R1.1 million after just 17 years**. If you were hoping to get there by playing the lotto then by that stage you would have played 1768 times – still far short of the 14million required to ensure a reasonable chance of winning. (If money spent on the slot machines was invested, it would take just seven years to get to the million).

So how about it? Think twice about buying that lotto ticket and rather put the money to work for your future by investing it. This would be a real chance to change your life for good!

That’s all for now.

Gregg

*the new power-ball lotto has odds of 1 in 24 million.

** assuming a real return of 5% & an inflation linked escalation on the contribution.

Related posts:

1. Unbelievable!
2. It’s so easy to save money
3. Inappropriate advice?

Just read an article online about how in these tough times one of the positive outcomes is that people seem to be investing more into their retirement funds. The bad news, though, is that it is still usually too little to enable most people to retire financially secure.

Of bigger concern for me, however, is that not only are most people contributing too little, but on top of this, most people are probably not taking enough risk on their funds. This has mostly to do with the fact that most funds are completely inappropriately named or labelled.

For example, where there is individual fund choice within a pension fund, there are usually 3 or 4 funds such as the “Aggressive Fund”, the “Balanced Fund”, the “Conservative Fund” and possibly a guaranteed or money market fund. On seeing the word “Aggressive”, most investors usually panic and run for the relative safety of the Balanced or Conservative Fund (after all this is retirement money so they don’t want to risk it). Balanced Funds in this context will usually have ±50% in equities with the Conservative Funds having even less. Now we know that the best way to beat inflation (over time) is to have exposure to equities. So while they will probably not lose too much in the down cycle as a result of this choice, they will most probably also not benefit sufficiently in the up cycles.

The problem, you see, is in the names of the funds. Remember that in terms of the investment guidelines for retirement funds, you can never have more than 75% of the total fund invested in shares*…so how can that ever be an “Aggressive” fund? In the unit trust industry, funds with 75% in equities are usually referred to as Managed or Balanced Funds. So why the inconsistency in naming when it comes to pension funds?

As a result of this inconsistency, my suspicion is that not only are people not saving enough money for their retirement, but on top of this, they are also being too conservative with their fund choices and as a result of this they will have even less than they expected when they retire.

Bottom line is that if you have time on your side (at least 12-15 years before retirement) you should most probably be in the most “aggressive” portfolio that you can – this is the greatest chance you have of achieving inflation beating returns.

So remember, when it comes to retirement money, you can not, by definition, have an aggressive fund – at least 25% of the fund will be in cash, bonds and property at any stage.

*yes, I know that technically speaking there could be up to 90% in shares and property, but the reality is that this is usually not the case, with most “aggressive” funds having 75% or less in equities with the balance in bonds and cash.

Related posts:

1. Dilbert on Finance
2. Just because it is raining it does not mean the drought is over!
3. Financial Planning for Dummies – Part 3

One of the biggest issues around bonds is that most people have no idea of the time-value of money and as a result have no idea of the total cost of their house over the 20 year period. The table below shows the repayments and total cost on a bond over the full term as well as what the required payment would be if someone wanted to pay their bond off over 15, 10 or 5 years. It also shows the subsequent saving in interest as a result of paying it off more quickly. R1 million bond over various periods @11% interest

Period      Payment/Mnth   Ttl repayments*       Difference                Saving
20 years     R 10 322              R 2 477 252
15 years     R 11 367              R 2 045 621              R 1 045            R 431 631
10 years     R 13 772              R 1 653 306              R 3 450            R 823 946
5 years       R 21 747              R 1 304 457              R 11 425          R 1 172 795

*this is the total cost of the R1 million bond over the period.

What most people fail to realise is that if they just leave their repayment where it is before yesterday’s cut, they will pay the bond off in just over 16 years and as a result will pay +/-R321000 less in interest. It also makes sense to build in an annual increase in your bond repayment – in much the same way that you have annual increases in your pension, RA or life policy contributions – by putting an annual escalation of 10% on the repayment you would pay your bond off in under 10 years at current interest rate levels and would save more than R825000 in interest!

Remember too, not to let the bank take the premium for the home owners insurance off your bond – you end up paying interest on this amount for the full term of the bond as a result (read the blog It’s so easy to save money!) for more on this.

Related posts:

1. It’s so easy to save money
2. Ignorance is not bliss!
3. Fundisa – it’s a no-brainer!

The answer, I think, lies not where you would expect it but rather in a very interesting bit of research that I discovered one day when reading about debt and credit cards. The research (from the USA ) is that people who buy day-to-day goods with a credit card are likely to spend 12-18% more than people who pay cash. More significantly, people who pay for food (and eating out) with a credit card will spend up to 54% more than those who pay for these expenses with cash. Seem unbelievable? Think about it! When you swipe your credit card, there is no emotional attachment to the purchase – you don’t feel it immediately. In fact, think back to the last time you swiped your card…what was the amount? I have amazed myself with this question. The number of times I have swiped my card, signed and walked away only to think a bit later “what was the amount”? Now imagine if you paid with cash and had to take R1500 out of your wallet (which you had to draw from the ATM)… I bet you would think a bit more carefully about whether or not you actually need everything that is in the trolley. Or think about the following scenario: you are on your way home from work and you need to pop in to buy bread and milk…but you don’t have any cash on you…so you use your credit card instead…but “bread and milk” is too little to put on a credit card so you pick up a magazine, some chocolate, chips and then you pay with the card…see how easy it is to spend up to 54% more? (In fact, the Healthy Food advert itself implies that people will end up buying much more than they need – think about the truck load of food that gets dumped on the lawn.)

I am not against credit cards (they have a place) but debit cards are a better bet (and safer than cash) – you cant spend money you dont have. I am also considering making June a “cash only” month and seeing if I actually end up spending less (I know it will be skewed because I will be more aware of what I am spending but isn’t that the point?)

Think before you swipe!

Related posts:

1. Do the maths!
2. Look after the small things…
3. Lotto – even if you are in you probably wont win!

The balance at 04 May is R1,209.56 (investment) and R518.00 (grant). Nedgroup Investment…i.e. there is currently R1727 in the account that would be paid to a tertiary education institution…

Not too shabby!

Related posts:

1. Guaranteed returns of 25%?
2. Minimum investments
3. Fundisa – it’s a no-brainer!