Salary earners who are lucky enough to receive an end-of-year bonus should stop and think that this money, or even half of it, could help you achieve financial freedom, an actuary says.
Niel Fourie, public policy actuary at the Actuarial Society of South Africa, says you may already have set your heart on something that will bring instant gratification, such as Christmas gifts, new clothing or something for your home.
But, he says, salary earners can achieve financial freedom, with the far greater rewards that come with that, if they delay gratification – that is, if they are disciplined enough to spend in line with a budget and use windfall money such as an annual bonus to whittle down debt rather than buy items of little long-term value.
“I don't want to sound like the Grinch who stole Christmas, but if, instead, you used your bonus money to reduce debt or to save, you could become debt-free much earlier than you think,” Fourie says.
Imagine being free of home loan repayments every month? Fourie says paying your bonus into your home loan could cut the term of you bond by almost half, depending on your circumstances.
And if you can’t face not spending any of your bonus on yourself and your family, spending half of it and paying the other half into your home loan could mean your bond term being much reduced.
Fourie says using your bonus in this way would not only save you thousands of rands in interest, but it would also free up a significant amount of money in future, which could then be used for other long-term goals, such as a child’s education or your retirement.
Fourie uses the example of a 30-year-old earning a net income of R24 000 a month and receiving a R24 000 net bonus at the end of November each year.
Assume you are this person and have just bought a house with a bond of R1 million, on which you have monthly repayments of R8 000 over 20 years.
Fourie also assumes your income and bonus increase with salary inflation of eight percent every year.
He says if you pay half of your annual R24 000 bonus towards your bond each year, you will reduce your home loan term by six year – to 14 years in total.
If you pay your full bonus into your home loan account every year, you would reduce your term from 20 years to 11 years, and be the owner of a bond-free house by the age of 41.
Fourie says the same is true for a mortgage bond that you have had for a number of years. Using the same assumptions, Fourie found that a five-year-old bond could be paid off in 10 years if you put half of your bonus in your home loan account and in eight years if you put your entire bonus in your home loan.
A bond taken out 10 years ago could be paid off in seven years if you paid in half of your bonus each year, and in five years if you paid your full bonus into the account.
Fourie says there is nothing wrong with using some of your bonus money to spoil yourself and your family. However, if you are servicing debt, your first priority should be to settle this.
Short-term debt, with the highest interest rates, such as credit card debt and clothing accounts, should be at the top of your list, followed by your car repayments and then long-term debt such as your bond.
He says if you are paying school fees, you could use your bonus to pay your school fees upfront and benefit from the five to ten percent discount often offered by schools.
If you then paid the money you saved on school fees into your bond, you would benefit twice: once from the discount and then from the interest saved on the outstanding amount of your home loan.
Fourie says that if you are not servicing a home loan, it would be wise to invest a portion of your annual bonus for your retirement.
“If you invest from your annual bonus the same percentage as from your salary, you are likely to end up with an eight percent bigger pension at retirement. If you decide to contribute your entire bonus towards your retirement savings every year, you are likely to end up with a pension of between 30 and 80 percent more at retirement, depending on your contribution percentage and salary.”