NZ Herald 10 December 2005

AJust about the last investment I would recommend for someone who is risk averse is a $29,000 house near Gore.

I assume you would rent out the property. And rental properties are riskier than many people realise.

In your case, you would presumably buy without a mortgage, which considerably lowers the risk. You’re not going to get caught in a cash flow crisis and have to sell when prices are down.

Still, unless you happen to live near Gore, you’ll be a long-distance landlord. That means either hiring a property manager, which will eat into your returns, or putting up with a lot of hassle trying to run things from afar.

Of more importance, though, are your prospects of getting good long-term tenants and of eventually selling the property at a gain.

I know nothing about the house. But its location and price tag suggest that reliable would-be tenants won’t be clambering to rent it.

What about capital gain? Surely, at such a low price, a gain must be inevitable?

Don’t be so certain. A seller who is asking only $29,000 must realise that potential buyers won’t foresee big growth prospects, once they’ve inspected the property and the local economy. Otherwise, they would be willing to pay more, and the seller would ask more.

If you were desperate to house a family, and had work in the area, that house might be a goer as cheap accommodation. But there’s no way it’s a low-risk investment.

Fortunately, there’s a great alternative for you. Put most of your savings — keeping a bit aside to come and go on — into paying off your mortgage faster than you have to.

Let’s say your mortgage interest rate is 8 per cent. If you repay $160,000, you avoid paying 8 per cent on that money. That amounts to the same thing as earning 8 per cent on it, and there’s no tax.

That’s far better than the 6.8 per cent you are currently getting, which will be reduced to 5.4 or 4.6 or 4.1 per cent after tax, depending on your tax bracket.

Paying lots off the mortgage is a move that could find you much better off in your retirement. It’s the ultimate low-risk “investment”. And you should be able to set it up so that you can get the money back out again if you need it.

Note that if you have a fixed-rate mortgage you might face a penalty if you repay it early. But discuss this with your lender. In these times of rising interest rates, lenders sometimes waive those penalties. They are happy to get the money back so they can lend it out to someone else at a higher rate.

If you can’t get out of the penalty and it’s a large one, leave the money in term deposits until the fixed-rate term ends, and then pay off the loan.

What if your mortgage is less than $160,000? Pay it off, and with the rest of your money consider buying several investment grade corporate bonds.

They are quite similar to term deposits, but are slightly riskier and pay somewhat higher returns. A stockbroker can help you buy low-risk ones.

And keep saving the money you have been putting into the mortgage — perhaps by buying more bonds.

AInland Revenue says it would take quite some time to come up with a total on the interest it earns — if such a calculation is even possible.

The department did, though, respond to your suggestion about adding interest to refunds.

“While interest is not paid to taxpayers on overpaid PAYE (pay as you earn taxes), interest is not charged on underpaid PAYE until any underpaid amount becomes due,” says a spokesperson.

“So if at the end of the tax year (usually 31 March) a person has short-paid PAYE on all their income, that short payment is not due until the following February — some 10 months later — and no interest is charged over that period.”

She also noted, “If PAYE is over-paid, Inland Revenue returns that overpayment within a maximum of six weeks of the tax return being filed or a personal tax summary being confirmed.”

That sounds reasonable to me. While we all love to hate Inland Revenue, don’t forget that its broad policies are set by politicians. And they don’t want to appear to be ripping off the public.

On your first point, I didn’t go into the time value of money last week because my answer was already getting too complicated for a Saturday morning read. I would rather readers grasped the main point than felt so bamboozled that they grasped nothing!

And, while the time value of money is hugely important over long periods, it’s not all that big a deal if you get a refund each year.

Let’s say you are over-taxed by $50 a week, so your refund is $2600. If you had, instead, received that $50 each week and saved it at 4 per cent, after tax, you would accumulate $2651 in a year. You’re $51 better off.

As you say, you might have put that money into repaying a mortgage faster. At a mortgage rate of 9 per cent, paying an extra $50 a week would take $2,713 off the mortgage, versus $2,600 if you used a refund at the end of the year. But that’s still not a big difference.

Admittedly, if you used the money to pay off a 19 per cent credit card debt, it’s more significant. It would reduce your debt by $2,835, compared with $2,600. That $235 is worth having.

Funnily enough though, when I lived in the US, where it was pretty easy to alter tax withholding, lots of people preferred a refund over lower tax through the year.

They thought of it as forced saving, even though it effectively earned negative interest. I suspect many New Zealanders would feel the same way.