NZ Herald 12 October 2019

AThanks for making two important points.

The first is about the link between interest rates and inflation, which is obvious in our graph. The graph also shows that there was a long period in the 1970s and early 80s when inflation — as measured by the consumer price index or CPI — was considerably higher than bank deposit rates.

Back then, while people thought their savings were growing fast, they were actually running to keep up with costs, and failing.

For example, if you deposited $100 at 12 per cent, a year later you would have $112. But if inflation was 15 per cent at the time, $100 of groceries at the start of the year would cost you $115 at the end.

These days, at least your money will buy more at the end of the year than at the start — despite low interest rates.

Your second point is related to the one I made last week, about how we should index tax brackets, so they rise with inflation. Without indexing, when our income rises, we pay more tax even though our income may not buy us any more.

And this is worse when inflation and interest rates are higher. Let’s go back to our deposit earning 12 per cent. If you were in the 33 per cent tax bracket back then, tax would have reduced your interest to 8 per cent — putting you even further behind in terms of buying power.

With current interest at, say, 3 per cent, tax reduces it to 2 per cent, and that will usually still keep you ahead of inflation — even if only slightly.

Conclusion: today’s low deposit interest rates aren’t as bad as they seem.

AI’m sure you expect me to say, “No, no, don’t splurge on a cruise!” But some retired people are too frugal, so maybe blowing a small part of your savings on a treat isn’t a silly idea.

Obviously, though, you need to look after your savings even more carefully than before, given that returns on bonds and term deposits have fallen considerably.

What’s more, as you note, short-term deposits currently pay about the same, or more, than longer-term ones. This is unusual. Normally you get more for locking your money up for longer.

The current situation means experts expect interest rates to fall over the next few years. And while the experts have been wrong before, it would be risky to count on rates rising soon.

So what can you do? Some ideas:

• Increase your risk — carefully. Don’t do this with the money you expect to spend within the next ten years. There’s too big a chance it will be in a downturn when you want to withdraw it.

  But you could put your longer-term money in a fund that invests in a wide range of shares. These days you can join a KiwiSaver growth or aggressive fund at any age. Use Smart Investor to learn about what’s available, and pick a low-fee fund.

• If you own a mortgage-free home, perhaps spend your savings by the time you are 80 or 85, and then get a reverse mortgage. That could give you several hundred thousand dollars to spend on cruises and everything else. For more on this, see last week’s column.
• Move to a cheaper house. Or take in boarders. Or subdivide. Or look into rates postponement offered by many councils — rather like a mini reverse mortgage. Or sell your house and become a tenant — no more maintenance worries! Or sell assets. There are many ways inventive retired people free up cash.

By the way, before you feel too sorry for yourself about low interest rates, see the previous Q&A. At least you’re doing better than retired people in the 1970s and early 80s!

That situation probably drove some of them to join the share buying frenzy that led to the 1987 sharemarket crash. Many people broke some investment “rules” then, such as investing in just a few shares, and borrowing to invest without realizing how risky that is. Let’s not do that again, everyone!

AOnly if you expect it to keep on getting returns of 7 per cent.

Pretty much all KiwiSaver funds have had unusually strong returns in the last few years. Shares have performed really well, but so have bonds — a big component of most conservative funds.

One reason bond funds have performed so well is that interest rates have declined. When that happens, older bonds held by a fund become attractive because they pay higher interest, and their value therefore rises. That is reflected in your high return.

But as interest rates level off — there’s not much further they can fall — that effect will die out.

Also, if your fund holds lots of overseas bonds, there’s been a similar effect from the fall in the value of the Kiwi dollar in the last few years. When our dollar drops, the value of foreign assets rises. That might continue, but it might not.

All in all, then, you should regard your 7 per cent return as exceptional. Over the long run, the return after fees and tax on a conservative fund is more likely to be around 2 or 3 per cent. It could even be negative some years if, for example, interest rates rise fast — the reverse of the recent effect.

Over all, though, your average returns should be a bit higher than on bank term deposits — reflecting the fact that there’s a bit of volatility.

And given you’re in a KiwiSaver fund, which is fairly closely monitored, there’s almost no chance you’ll permanently lose money.

I would put some of your savings — say half — in the KiwiSaver fund. But — given your signoff — you might want to leave half in deposits, which will never have negative returns.

However, consider being braver with some of the money you won’t spend for a decade or more. That could go into, say, a KiwiSaver balanced fund, which should give you somewhat higher average returns over the long term — as my book explains.

AGood tips from the voice of experience.

I doubt, though, that apartments will always appreciate more slowly than houses. True, the apartment market is somewhat different, and has probably been affected in recent years by a bigger increase in the supply of apartments than houses.

But if apartments became hugely cheaper than houses of a similar quality, demand would rise for them, pushing their prices up. I’m sure there will be periods in future when apartment prices outpace house prices.

It’s interesting, though, that the two markets can apparently get quite out of whack at times.

Your mention of body corporate levies reminds me that I’ve heard plenty of stories from apartment owners struggling with body corporate disagreements. It’s hard to get everyone on the same wavelength when it comes to, say, expensive long-term maintenance, or improvements that some owners don’t think will improve anything.

It seems that when people sell their home and buy an apartment they trade one set of complications for another. Sigh.

AAnd I beg to differ — about the US situation! In many cases Americans don’t pay capital gains tax when they sell their homes.

But let’s not get into that. Your main point is fair enough. When I moved back to New Zealand from the US, it seemed unfair that mortgage interest wasn’t deductible here. But I understand what you’re saying.

By “owner occupied rent” you’re talking about the fact that homeowners live in their homes, and that’s a benefit — like income really — that they don’t pay tax on.

This is sometimes called imputed rent. Various experts have at times suggested it should be taxed as income, as is done in some European countries. Presumably in those countries mortgage interest would be deductible.

Another reader made a similar point: “The home mortgage could be deductible if you were also taxed on the accommodation benefit you receive — an "imputed rent" that you don't need to pay because you own. Would certainly generate my property accounting business some extra work!”