Money into your bond
Advisors are frequently asked this question. This often has more to do with personal risk preference than with economic rationality. To answer this question, however, certain assumptions must be made, and I specifically won’t look at tax to keep the answer succinct.
The rational answer
Let us assume that the interest rate on the bond is at the prime lending rate. That is currently 10.50%
The second assumption we need to make is about what the risk level of the unit trust in question is. A money market unit trust has a very different risk and associated return goal than an equity unit trust.
A low-risk money market or income fund aims to beat inflation and offer a real return of 1% per annum. Thus, if the R100 000 is in an income unit trust only yielding 7% to 8%, it would be rational to secure the higher guaranteed return of 10.5% and transfer the funds into the bond.
However, if the money is in a balanced fund which generally targets a 5% real return, it would be more rational to remain invested as the real return is in excess of the bond interest rate.
It is also important not to fall into the trap of looking at the short-term underperformance of equity linked funds in a time like now and compare this to a resilient prime rate. This may result in the wrong decision to sell out at the wrong time. Every situation is unique and the best course of action is to get advice from a financial advisor who will look at the big picture and your individual circumstances.
The subjective answer
The other way I would advise a client on this is a more subjective approach – the sleep test. Quite simply, what makes you sleep better at night? Would that be a bond balance of R100 000 lower than it is now with no funds invested, or the same outstanding bond balance but R100 000 invested?
The answer will be different for each individual and there are a lot of factors that influence one’s financial decision making such as your view of debt as either toxic or as an enabler. For some people having R100 000 invested offshore, for example, gives them comfort. Therefore, because the economic rationality argument is often such a close contest, considering the subjective approach may help make the final decision easier.