NZ Herald 20 November 2021

AWow. You are impressive, having $20,000 invested at your age. And I really like your choice of low-fee passive investments.

Apparently many of your mates are pretty good savers too.

“Eighteen to 24-year-olds emerged as New Zealand’s strongest savers through lockdown, increasing their average cash balance by $600 (or 9 per cent) during September,” says ASB chief executive Vittoria Shortt. “This compares with an average of around 5 per cent for all other age groups across the same period.” Well done, you guys!

Your next steps depend, really, on whether you want to buy a home within the next ten years. If so, I suggest you move your deposit money into medium-risk funds, to protect it against a market downturn near your withdrawal time. And when you are within two or three years of buying a home, switch to low-risk funds.

But you may not be eyeing home ownership, and that’s fine too. Even if you never own a home, all will be well as long as you reach retirement with enough savings to cover your accommodation costs for the rest of your life.

If you’re planning to invest over many decades, there’s one way you can up the ante. It’s something I considered in my twenties, but didn’t quite have the courage to do.

What I’m talking about is borrowing to invest, preferably in a low-fee share fund. You won’t find it in my book because it doesn’t suit most people. You have to be brave, and have stickability.

Borrowing to invest — sometimes called gearing — is most commonly done in property. As long as the property value grows over the years, you get the gain on the borrowed money as well as your deposit. Sure, you must pay interest on the loan. But hopefully the rent you receive will cover that and other expenses.

The downside is that if you are forced to sell the property at a time when prices have fallen — and it does happen — you can end up with no money and a debt. You’re way worse off than if you hadn’t borrowed, when the worst that can happen is you lose your money.

It’s similar with shares. Hopefully the dividends will cover your interest payments. In a fund, you’ll have to withdraw the dividends to pay the interest, but that’s okay. As long as the shares grow in value over time, you benefit from gains on the borrowed money as well as your own.

This is risky stuff:

• You must be confident you won’t ever have to bail out of the investment unexpectedly — perhaps in a market slump.
• Interest rates might rise considerably. In some years your dividends may not cover the interest, so you’ll have to sell some shares.
• Over the decades, the total returns on the shares must be considerably higher than the interest you pay, or it’s not worthwhile. In the past that has tended to be the case, but who knows about the future?

And there’s an obvious hitch. It’s easier to borrow to invest in property than in shares. Still, you can borrow from some sharebrokers, or perhaps a family member. Or if you buy a home with a revolving credit mortgage, you could add to your mortgage.

If you decide to do this, start out small, and see how it goes — including how you feel when share prices fall for a considerable period.

Or…. You could just keep doing what you’re doing. There’s no need for you to take the risk of gearing unless you want to. With the start you have, you are going to be fine financially.

ANo! It seems I haven’t made a really important point clear. The money you hold in shares should always — not just at the start — be money you plan to spend ten or more years hence.

If your spending will be in a lump sum sooner than that, move your money as described above for the purchase of a home within the next decade.

But let’s say you have $200,000 and plan to spend $10,000 a year for the next 20 years. To keep it simple, we’ll ignore returns on the savings in the meantime.

The basic idea is that you start with:

• $30,000 for the first three years in bank term deposits or a cash fund, so the balance can’t drop right before you spend it.
• $70,000 for three to ten years in a bond fund.
• $100,000 for the longer term in a share fund.

Once a year, move $10,000 from the share fund to the bond fund, and $10,000 from the bond fund to the cash fund, to maintain your time horizons. Meanwhile, you will have spent $10,000 from the cash fund.

In some years the share market will have dropped, so moving the money out of shares will hurt. But in other years you’ll be moving when prices are high. It all comes out in the wash.

However, you can be a bit flexible. If shares have crashed, you can wait a while in the hopes of a recovery. And if shares have boomed, you might move next year’s money as well as this year’s. That’s the beauty of having ten years to play with.

By the way, while some people say ten years is too long for the ten-year rule, you could argue it’s not long enough.

Financial advice provider and researcher Brent Sheather tells me that after the 1929 Crash “even waiting 15 years didn’t guarantee the return of your capital — excluding dividend income.”

Also, he says, between 1969 and 1981, when inflation in the US averaged 7.1 per cent a year, “the stock market not only didn’t keep up with inflation — it underperformed by about 40 per cent.”

He adds, “These were extreme events, but there is no guarantee something like them won’t happen again.”

Indeed. It’s always wise to work through a worst case scenario — while hoping for the opposite.

AThat’s a great idea. The idea of saving for retirement probably won’t mean much to the boy now. But he might like the idea of saving to buy a first home in his twenties or thirties.

You could, perhaps, encourage him to contribute small amounts, even though he won’t get government and compulsory employer contributions until he’s 18.

In a growth fund, which will be largely invested in shares, his balance will sometimes fall. You might want to teach him what that means, and show him that if he sticks with his investment it will come right.

I suggest you use the KiwiSaver fund finder on sorted.org.nz to find a low-fee fund that also gets good marks for services.

AOn your first question, usually you will pay tax even in a loss year. This is a bit complicated, so we’ll take it a step at a time.

Tax is paid on your PIE income at your PIR rate, says an expert. And your PIE income will generally be different from your investment return.

If, for example, your KiwiSaver fund holds New Zealand or Australian shares, the total return on those will be dividends received plus or minus changes in share prices. But in a PIE you are taxed only on the dividends — regardless of whether the market falls or rises.

Other overseas shares are taxed under the FDR (fair dividend rate) regime. No matter what the return is, your PIE income will be 5 per cent of the value of the shares.

However, local and overseas bonds are generally taxed under the “accruals regime”. If the return is negative — which can happen if interest rates rise and so bond values fall — the tax is negative. In other words, you get a refund.

Luckily, your provider takes care of all this for you.

Your second question is simpler. Phew! As I said last week, you can make your contribution any time in the July-to-June KiwiSaver year that you turn 65, including after your birthday. However, to get the government money, your contribution must be made before you make any withdrawals.

AExcellent! Now how about trying more expensive food, or going to a play instead of a movie — when we’re allowed to do those things again?

If there are no pricier treats that make you happier, I’m sure there’s a charity that would love your help.

AFair point, although the reader was just wanting a KiwiSaver fund with investments that included oil and gas. All KiwiSaver funds, to my knowledge, are widely diversified.

On investing in the company that employs you, some companies allow employees to buy their shares at a discount. That usually makes it a good investment, although you often have to hold the shares for a period before selling. Who knows what the price might do in the meantime?

As you say, the company could even go broke and you lose your job. So it wouldn’t be wise to invest more than a small chunk of your savings.