What to know about the elephant in the room – the one you bought on credit
“Personal debt – particularly the levels of debt that people in South Africa have accumulated – is destroying our hopes of a confident financial future for ourselves and our children.” So says Sherwin Govender, business development manager at Glacier by Sanlam. “It’s the elephant in the room that we rarely talk about.”
What exactly is wealth, and why is debt often a problem?
“In the simplest terms, wealth is what you own; the value of all of the money you have (your assets), minus the money that you owe (liabilities).”
As an exercise, look at the total value of your accessible assets, such as investment property, tax-free savings accounts and fixed deposits. Subtract the total value of all of your debt, such as your mortgage bond and the outstanding balance on your car and credit card, from your accessible asset value. If the outcome is positive, then congratulations! This means you have disposable funds that you can use to grow your wealth.
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INFO TAB:
Assets are items of property owned by a person or company, regarded as having value and available to meet?debts,?commitments or?legacies.
?Why are retirement savings not counted as an accessible asset? It’s very simple: your retirement savings are there to pay you an income when you retire. Every rand that you use before you retire, is a rand plus compound interest that you will not have, when you really need it in retirement.
Compound interest is?the interest that you earn on interest. It’s basic math, really: if you have R100 and it earns 5% interest each year, you’ll have R105 at the end of the first year. At the end of the second year, you’ll have R110.25. Not only did you earn R5 in interest on the initial R100 capital, but you also earned R0.25 in interest on the R5 interest.
The sum to establish your wealth is simple: assets minus liabilities.
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Let’s get to know Pam and do some math for her.
Pam wants to upgrade her car. It’s an entry-level vehicle and was new when her father bought it for her in 2017. It cost R100?000 then and now it is worth R80?000. There is nothing mechanically wrong with her car. She gets it serviced regularly, for which she pays in cash, as the service plan has run out. The car is fuel efficient and Pam spends about R2 500 per month to run her vehicle.
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She has her eye on a new car which will cost R200?000. She plans to trade in her car but will need vehicle finance to be able to afford the balance on the price of the new car.
The table below illustrates what she will need to borrow from the bank and the repayment plan:
Pam has reorganised her budget to be able to afford repaying the debt on the new vehicle.
What if Pam invested the money instead of buying a new car?
Let’s imagine Pam decides to keep her current vehicle and invests the monthly instalment of R2 814 in a tax-free savings account instead. After five years, she will have accumulated R206 764 , which she could use to buy a vehicle (a depreciating asset) without incurring debt, or she could use it as a deposit on a house (an asset that grows in value). This investment will have the potential to create wealth whereas the car loses value every day.
What to know about debt
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All calculations in this article are for illustrative purposes only. Investment returns are subject to market fluctuations and the resultant underlying fund performance.
Glacier Financial Solutions (Pty) Ltd is a licensed financial services provider.
Sanlam Life Insurance Ltd is a licensed life insurer, financial services and registered credit provider (NCRCP43)