7. Not managing credit or store card debt
Too many people use the “plastic safety net” to cover their basic living expenses. Till assistants at retailers, even at food stores, routinely ask, “Straight or budget?”. In other words, South Africans are surviving on plastic. A budget facility on a credit card is a misnomer. In fact, “budget” in this case is a banking industry euphemism for “often unaffordable debt”.
Rajeen Devpruth, the manager for research and statistics at the National Credit Regulator, says there are 22 million credit cards, stores cards, garage cards and bank overdrafts in the hands of consumers, who owed R140 billion (R57 billion on credit cards alone) as at December last year. Of this debt, more than 25 percent had been outstanding for over 30 days and almost seven percent for over 120 days.
In the last three months of last year, 2.6 million new credit, garage and store cards were issued, which allowed the holders to borrow up to R4.5 billion.
Credit card debt is unsecured debt. In other words, you do not have to put up any security that you will repay the debt. The consequence is that banks charge high rates of interest on credit card debt, because the defaults are far higher than on home loans, where the banks can repossess your home if you fail to repay your loan.
Credit cards are a wonderful, secure facility if you use them sensibly to pay for goods and pay back the money owed within the time allotted, avoiding wasting money on interest, and worse, defaulting on the due date for payment of the minimum amount.
Standard Bank compiled the following scenarios for Personal Finance to demonstrate how much you could end up paying if you spend R30 000 using your credit card with an interest rate of 18 percent:
• Scenario 1.
You spend the R30 000 at a point of sale (PoS), such as a furniture retailer. You will not pay any interest if you repay the full amount of a PoS purchase within the billing period. You have a maximum of 55 days to pay, depending on when in the billing cycle you made the purchase.
However, if you withdraw or transfer cash from your credit card account, interest becomes payable on the amount you withdraw or transfer. If you withdraw the R30 000 on the first day of a statement cycle, the interest will be R444 (R30 000 x 18 percent x [30/365 days]).
• Scenario 2.
You pay the minimum amount of five percent of your outstanding balance every month and do not spend any additional amount.
In addition to repaying the R30 000 capital, you will pay R12 469.96 in interest if you repay the full amount within 135 months. The 135 months is largely because the minimum monthly payment of five percent of the balance is based on the previous month’s closing balance. As a result, the monthly repayment will drop significantly over time. For example, R1 522 is payable monthly in the first year (a total of R14 047) versus R25 in the last year.
• Scenario 3.
You keep your credit card debt at R30 000 for one year, or five, 10, or 15 years. The total interest you will pay (at 18 percent) is R5 231.97 over one year; R26 101.42 over five years; R52 188.23 over 10 years; and R78 275.04 over 15 years.
Alan Hales, the director of Standard Bank consumer cards, says a budget account transaction has a maximum elective repayment period of 60 months (five years).
In the case of credit agreements entered into before the implementation of the National Credit Act (NCA) on June 1, 2007, the interest rate on budget transactions is lower where a balance of R10 000 or more is maintained. Where the balance is less than R10 000, there is no difference in the interest rate charged for agreements entered into before or after the NCA.
For credit agreements entered into on or after June 1, 2007, the interest rate on a budget facility is the same as the interest rate on PoS spend.
The total minimum repayment on a straight or budget facility is made up of five percent of the straight facility balance plus the amortised repayment on the budget facility amount. The amortised amount is calculated by taking into account the interest rate, the repayment period and the value of the budget transaction.
8. Not reading loan agreements carefully
Although the NCA protects you to some extent from exploitation, many conditions that are camouflaged in the fine print of a loan agreement could come back to haunt you.
In terms of the Act, you must be informed in clear language of all the issues that affect your debt. This puts the onus on you to read all the documents before you sign anything. And you must understand the implications of what you are signing.
Nowadays, most businesses that sell goods on credit are more akin to financial services companies than traditional retailers. The financial products that are sold around the product are where the profits lie for the retailer. And the consequence is that you could pay 10 times more for an item than you would have paid if you had used cash. The retailer will:
• Either earn interest on the loan itself or in effect receive a kickback or commission from the financial institution that provides the credit.
• Earn commission on the life assurance it will insist you take out to cover the debt. But remember that you cannot be forced to purchase assurance from the retailer or from a company of the retailer’s choice. Credit life assurance is the biggest money-spinner in the life assurance industry. Life assurance bought directly from a life assurer is likely to be far cheaper. Here are a few rules to avoid needless payments:
* Never take out credit life assurance for a period longer than the period over which you must repay the debt.
* Never take out credit life assurance for an amount greater than the debt.
* Preferably take out credit life assurance where the value of the benefit declines in tandem with the outstanding debt.
* Always insist on getting quotes via a financial adviser who is independent of the retailer.
* Remember that the commission paid on credit life assurance is calculated by multiplying the premium and the term of the assurance by a certain factor. So the bigger the premium and the longer you pay, the greater the commission.
* Always pay the premiums on the life assurance separately from the principal debt on the product. Most times the premium is added to the principal debt, and you pay interest on the larger debt.
• Earn a commission of up to 22.5 percent on short-term insurance. You will be required to take out short-term insurance, but again you can choose the product provider. And again, beware of premiums being added to the principal debt, which will result in your interest bill climbing.
• Make a profit by selling you extended guarantees and service plans. In many cases, you do not need an extended guarantee.
• Apply other charges, such as administration and penalty charges – even if you pay back the debt early.
9. Not following basic rules of investing
There are 10 very simple investment rules that are broken repeatedly at great cost. Too often, the people who break these rules are the ones who can least afford to do so: pensioners. The reason is that pensioners have often not saved enough for retirement and so make bad investment decisions in the hope of securing a quick windfall.
The 10 most important investment rules are:
1. Do not put all your eggs in one basket. Time and again, South Africans fall foul of this very basic rule. Investors are taken in by what they see as a fantastic opportunity to make a quick buck and resort to the cliché: in for a penny, in for a pound. And the victims do invest every available penny, with the real lunatics also borrowing money to invest even more. The chances are they will lose it all.
The investment need not be a scam. Take for example the various recent investment bubbles, whether information technology or emerging companies. Most of the investments were in companies listed on properly controlled stock exchanges, the companies were appropriately managed and the companies themselves did not go bankrupt. But it was what former United States Federal Reserve chairman Alan Greenspan termed the “irrational exuberance” of investors and their advisers that drove prices to unsustainable levels.
Fortunately in South Africa, retirement funds are forced to diversify our savings across a broad range of assets, including shares, bonds, property and cash. This is unlike in the US, where thousands of Enron employees face destitution because all or most of their retirement savings were invested in Enron. They did not suspect that the company’s stock would plummet by nearly 99 percent in 2001.
But when it comes to our discretionary investments, we are not protected against ourselves, unless we invest in balanced or flexible products.
Too often, the basic rule of diversification is ignored because of greed and fear. Greed, because investors want to be part of the action, and the fear that they will otherwise lose out.
The key is to diversify your investments across asset classes and within asset classes. By adopting this approach, if one investment bombs, having money in other investments will limit your losses.
2. If it sounds too good to be true, it normally is. This rule applies to investments where you are “guaranteed” returns that are way out of line with the prevailing interest rates. More often than not, the guarantees, both on the capital and the returns, are phoney. The examples range from legal structures, such as property syndications (for example, Masterbond and City Capital), to barely legal structures, such as Jack Milne’s PSC Guaranteed Fund and the Leaderguard foreign currency scam, to totally illegal pyramid structures, such as the Rainbow and Airplane schemes.
3. It is time in the market, not timing the market. Many people believe they can judge when the time is right to make an investment and to withdraw from an investment. You may get it right once or twice. In most cases, you will get it wrong.
Although the evidence of the recent investment market crash shows that South Africans are starting to behave better, too many people still jump out of investments when markets fall (realising their losses) and then get back in when markets are nearing their peak (buying when prices are high).
Investment markets, particularly share markets, are volatile, often frighteningly so, but if your initial investment decisions were sound and you invest for the long term, history has shown you have a far better chance of reaching your financial goals. Most of your returns over the long term will not come from the money you save but from the compounded returns on your savings. It is a marathon, not a sprint.
4. Judge risk correctly. All investments contain some risk. But you should not assess investment risk from the perspective of how much money you want or need to make, or whether you have nerves of steel, but of how much you can afford to lose both in the short and the long term.
5. Do not be too conservative. One of the main enemies of investors is inflation. Most cash investments will not keep ahead of inflation because of the relatively low interest rates and the tax you pay on interest earnings. In other words, the buying power of your money will reduce year on year. At an inflation rate of 10 percent, R1 will be worth only 90 cents the following year.
6. Do not make emotional decisions. Sure, your friend’s start-up business sounds like an exciting venture, but if it fails, can you afford to lose the R100 000 you are thinking of investing in it?
Emotions are powerful and when left unchecked they can influence you unduly to make decisions that are not in your financial best interest.
Whether you are considering pulling out of the market (and potentially losing out on long-term gains), because you are panicked by a drop in the FTSE/JSE All Share index, or co-signing a loan, because you feel sorry for a family member who is down on his or her luck (and potentially being stuck with a loan you cannot afford to repay if he or she defaults on it), do your financial due diligence and get an expert second opinion before you risk making a choice that is going to cost you in the long run.
7. Be alert to commission-driven product-floggers. These people are fairly easy to identify because they:
• Tend to want to sell you one thing;
• Try to convince you to invest the maximum amount;
• Put pressure on you to sign up immediately;
• Make vague verbal promises;
• Often use glossy marketing material;
• Use complex jargon, which neither you nor they really understand; and
• Attempt to persuade you to cancel an existing investment to take out another.
And the real nasties will try to convince you to borrow money, for example, against your home, to make the investment. If you encounter any of these sales tactics, you should be very, very wary.
8. Always check. Do not take anyone at his or her word. For example, carry out independent checks on whether a person who is giving you financial advice is registered with the Financial Services Board (www.fsb.co.za) and whether he or she is licensed to sell a particular product. Ensure that the product provider is properly registered and that the products, such as collective investments, are regulated. Obtain all assurances and details in writing.
9. Check the costs. Costs can significantly undermine your end benefit. Every one percentage point you save in costs will improve your end benefit by almost 20 percent over 40 years. It is not that you can avoid costs; it is the extent of the costs that is important. Any cost in excess of three percent a year, including all commissions/advice fees, should be considered excessive.
10. If you do not understand it, do not touch it. There are many legal but very complex products on the market. If you do not understand how a product works, do not touch it, because nasty surprises are likely to be hidden in the fine print.
10. Not planning for a long life You cannot simply sit back and relax once you retire.
You still face financial dangers that could leave you destitute at the very time you can least afford it. For most pensioners, there is no road to financial recovery if things go wrong.
The dangers are: you will not have saved enough; you will make dangerous pension choices; you will outlive your savings; and inflation will gradually impoverish you.
• Disjointed investment policies. Anderson says disjointed investment strategies before and after retirement could cost you dearly. For example, if you have most of your money in a high-cash portfolio shortly before retirement and then switch into a high-equity portfolio at retirement, you could make the switch when markets have peaked, exposing you to a market timing risk.
• Longevity. On average, people who reach retirement and who are out of the HIV/Aids high-exposure zone are living longer. This means you need to have saved more money for the years you will spend in retirement. If you are already short of money when you reach retirement, living longer will only make matters worse.
In his book Retire Right, Personal Finance editor Bruce Cameron says the problem is that many people, and their financial advisers, use average ages when calculating how many years they will spend in retirement. If, when you retire at 65, you base your calculations on when you will deplete your capital in an investment-linked living annuity (Illa) on dying at the average anticipated age of death of 82 for a man or 86 for a woman, you could have a serious problem if you live longer. And there is a 50-percent chance that you will live longer.
An Illa is a non-guaranteed pension where you decide how much, between 2.5 and 17.5 percent of the annual value of the capital plus the returns, you want to draw down as a monthly pension.
Mortality tables show that at least one person of a couple aged 65 has a 99-percent chance of living to the age of 70, a 96-percent chance of reaching 75, an 88-percent likelihood of reaching 80 and a 52-percent chance of living to 90.
Research by Danie Wessels, of Cape Town-based financial services company Martin Eksteen Jordaan Wessels, shows that both the rate at which you draw down a pension from an Illa and the investment returns will affect the sustainability of your pension.
For example, if you base your calculations on a conservative return of inflation plus three percent and a draw-down rate of five percent, your pension has a 100-percent chance of being sustainable for 10 years, a 99-percent chance of surviving for 15 years, a 25-percent chance of lasting for 25 years and only a six-percent lasting for 30 years. However, if you assume a return of inflation plus three percent and a draw-down rate of 10 percent, your pension will not be sustainable for 10 years.
• Inflation. A pensioner’s biggest single enemy is inflation. If you do not structure your retirement investments to take account of inflation, you will find that the buying power of your pension will decrease rapidly. Even with single-digit inflation of 4.5 percent a year, the buying power of a fixed monthly pension will reduce by 25 percent every six years.
Pensions can be divided into two broad categories: guaranteed pensions and Illas. Guaranteed pensions come in many different forms. If you select what is called a level annuity, which will pay the same amount for the rest of your life, you will quickly run into the brick wall of inflation.
However, buying a guaranteed pension that will protect against inflation is expensive. For example, a 60-year-old man with R1 million could receive a level annuity of about R9 300, depending on the prevailing interest rates. This is in contrast to a starting pension of R5 300 a month that will increase every year in line with inflation. After about 13 years, the inflation-linked annuity will exceed the level annuity.
• Taking big investment bets to overcome a shortfall in retirement capital. Many pensioners purchase Illas because they believe that living annuities will allow them to improve their financial situation by making high-risk investments.
But responsible financial advisers warn that no pension structure will make up for a lack of retirement capital. All you do is face the risk of making yourself even worse off.