It might seem like a good time to use a loan as a short-term bridge, but investors urged not to borrow.
In times of financial crisis, often when the stock market is at its most volatile, the South African Reserve Bank uses interest rate cuts to help consumers by way of lowering the cost of borrowing money. Following rate cuts last month, investors who are experiencing acute cash flow problems — perhaps due to a Covid-19-related loss or reduction of income — are finding it increasingly tempting to take out a loan and avoid cashing in their long-term investments.
Disinvesting when the market is at its lowest is painful for investors as it prevents them from benefiting from the market recovery, says Gontse Tsatsi, Head of Retail Distribution at Old Mutual Investment Group. “It might seem like a good time to use a loan as a short-term bridge to see out Covid-19. However, my message to investors is to avoid going into debt — no matter how attractive the interest rate may be”, says Tsatsi.
While Tsatsi says he does not want to encourage investors to sell off assets, a considered disposal is a better option. “The cashing in of unit trusts, especially those with exposure to growth assets like equities, demands a delicate balance between meeting immediate needs and future financial demands.”
“However, taking out a loan in the current interest rate environment is a gamble because rates will climb again as economic activity resumes and prices rise.”
“While it is unlikely that interest rates will soar soon, investors could be exposing themselves to great risk should they lose their job, for example, or get caught wrong-footed if conditions change quickly, giving rise to higher interest rates,” says Tsatsi.
He says a loan would makes sense if South Africa were to fall into a negative interest rate environment, as is the case in Denmark, Japan, Sweden and Switzerland. “The only time you ever use a loan is when rates are negative, and I dont see us getting there any time soon. It might make sense if the rate was as low as 1%, but I remain sceptical of it reaching that point. You would then need to have a guarantee that for the time you hold this loan, your investments always grow at a faster rate or else you would be going backwards”.
Tsatsi says that he realises that disinvesting is particularly tricky for younger investors whose portfolios are heavily skewed to equities.
According to research by Old Mutual Investment Group, had an investor over cautiously withdrawn their money from the stock market 20 years ago, and subsequently missed the 10 best performing days of the JSE (Johannesburg Stock Exchange), their investment would have lost out on potential growth of 44%, than if they had remained invested over the entire period.
Tsatsi encourages investors to consider every other option, like reducing household expenses, or finding other ways to increase income — as opposed to disinvesting or, worse still, taking a loan.
“Should investors have a variety of unit trusts for various financial goals and absolutely have to liquidate to meet their basic needs, I would say start with cashing out from funds with lower risk assets. These are assets like cash, which tend to show the lowest rates of volatility, meaning that during a crisis, they are more stable. This would include cashing in money invested in an income fund,” says Tsatsi.
However, Tsatsi emphasises that this doesn’t apply to people in or nearing retirement as a significant amount of their total investments would be in this type of solution.
“Longer-term damage to one’s overall portfolio would be minimised if these assets are sold because their long-term growth potential is lower.”
He says that he would also look to growing an emergency fund as a fall-back for future emergencies. “A little bit of future planning can go a long way to avoiding financial distress should something like Covid-19 happen again,” concludes Tsatsi.
“For an emergency fund, I would say lower risk unit trusts like income funds are the ideal option. This is also because unit trusts are ring-fenced, which means that they are secure in that they don’t form part of the balance sheet of the financial services provider. This makes them ideal during an economic downturn. Starting to invest in a low-cost fund with moderate growth potential now is one way to prevent having to consider a loan someday in the future.”