Has the tax man given you a refund? While the urge to splurge may be overwhelming, think carefully before you spend. Embracing instant gratification at the expense of long-term financial wellbeing is a common pitfall that trips up many investors, says Allan Gray's Jeanette Marais.
There's nothing quite like a windfall – whether it's an end-of-year bonus, a pay-out from your insurance company or a refund from the South African Revenue Service.
"Often a windfall feels like free money – a reason to spend," says Jeanette Marais, director of distribution and client service at Allan Gray. "But actually a tax refund implies that you've been paying too much tax during the year and the government is repaying you for an interest-free loan."
Marais outlines some common traps we tend to fall into when we come into money, and offers some alternative suggestions:
Pitfall No 1: Paying off your credit card and using this as an excuse to start spending again
While paying off debt is a good idea, merely reducing your credit card balance in order to rack it up again is not.
"This is short-term thinking at best," says Marais. "Pay off as much as you can of the debt, pack the card away, and invest what would have been your monthly repayments before you get used to having the extra money in your account."
Many investment managers, such as Allan Gray, allow debit orders of as low as R500 per month into unit trusts, tax-free investment accounts and retirement annuities. A little can go a long way over time.
Pitfall No 2: Putting the money in a low-interest savings account
If you come into extra money saving it is an excellent idea. If you don’t have an emergency fund in place, this is a good time to get one started. While you don’t want to take on risk if you feel you may need to access this money at short notice, it is a good idea to consider a money market or conservative unit trust, rather than simply using a low-interest savings account at a bank.
"Even if you don’t have a long time horizon, it is important to give yourself the best chance of keeping up with inflation," says Marais.
If you have no immediate need for the money, Marais suggests putting your SARS refund into your retirement savings or other investment accounts. "With a long time horizon, this has the potential to result in more robust growth," she says.
Pitfall No 3: Buying a car
Even though a bigger-than-expected refund might mean you're able to put down a deposit on a new car, consider the long-term impact.
"Make sure you can afford the monthly repayments, insurance and maintenance costs," says Marais. "Given that this type of asset needs to be paid off over time, compound interest will be working against you," she says.
It's worth considering that cars depreciate on average – which of course means they lose value - by 17% a year, while over the past 20 years, the average balanced unit trust fund has delivered returns – or gained value - of about 14% per year (according to Allan Gray research).
"Saving in a balanced fund is undoubtedly a better investment than a new car," says Marais. "If you are able to put your pressing need for new wheels aside, this decision may be better for your financial health over the long term."
Pitfall No 4: Splurging on a holiday or big-ticket item
There's nothing wrong with taking a well-earned break or indulging in some retail therapy, however, it is important to consider the long-term impact of your choices.
"Putting money aside for a rainy day, or into your retirement pot, may be a wiser choice, if your personal circumstances allow," Marais says.
She notes that balance and moderation are good habits to foster, and this extends to your finances.
"It is important to stay motivated when you are saving," says Marais. "Consider rewarding yourself with something small, and putting some money aside in an investment, and that way you get the best of both worlds."