Rochelle writes: High Rates – Save or pay down debt?

However, rate hikes do offer good news for people with spare cash. They can either pay down their debts or invest/save more. I asked my Twitter followers which one of the two options is best, and the votes were almost split down the middle. This shows that a case can be made for both – one just simply needs to sit down and do the numbers to determine what action to take.

The argument for paying down debt

Secured debt (debt that has an asset attached to it, like a home or car loan) normally comes with lower interest rates than unsecured debt. Unsecured debt includes mashonisa loans (loans from unregulated lenders), personal loans, credit cards, etc.

When it comes to credit card debt, many South Africans are paying the maximum interest that can be charged on a credit card annually. This rate currently sits at 19.5% (the formula, as per regulations, is the repo rate plus 14%). Show me an investment product that can guarantee 19.5% returns and I will show you a scammer. So herein lies the argument: Pay down credit card debt if you’re paying high interest rates.

Another rationale for paying down debt is your credit score. A high credit score gives you negotiating power, and therefore access to cheaper debt. This is ideal if you plan to make a large purchase like a home or car. On the flip side, excessive debt decreases your credit score.

However, the most important reason for getting rid of debt is the fact that a good night’s sleep is priceless. If you lose sleep because of interest rate hikes, you may be over-indebted and need to pay it down. In this case, investing your spare cash won’t solve your problem, even if you can earn better returns by investing.

The argument for saving/investing

If you have debt that charges lower interest than what you can get from saving/investing, the rule of thumb to follow is to save/invest first and then pay the regular debt instalments. If your bond is at prime (currently 9%) and a savings vehicle returns 11% (e.g. the current five-year Retail Savings Bond), you should be saving.

If you’re considering investing in the stock market, please remember that it can get complicated. Unlike bonds, the stock market is unpredictable, and returns are not guaranteed. You need to determine your personal risk tolerance for stock market volatility. Investing in ETFs, however, is much simpler and less risky – especially if you’re starting out.

The best of both worlds

I always find this argument between ‘save/invest first’ or ‘debt first’ funny, because I believe human beings are the most adaptable and nifty species on earth. We can do more than one thing at a time, so the need for extremes is redundant. You can save, invest and pay down debts at the same time. All you need to do is to set up a plan for yourself:

• If you have excessive debt, prioritise debt.
• If you have debt at very high interest rates, prioritise debt.
• If you don’t have an emergency fund, prioritise saving.
• If you have some spare cash and want to invest, find a suitable instrument and invest. I suggest starting with ETFs in your Tax-Free Savings Account (TFSA).
• If your TFSA is maxed out, start looking at individual stocks that suit your risk tolerance.

We truly can do it all as humans.