NZ Herald 26 August 2023

AYou’re referring to last week’s Q&A about saving money usually spent on coffee and lunches. But you’ve brought up another issue: passing judgement about how others spend their money.

It’s so common to hear people say something along the lines of, “Sam and Chris are always complaining that they’re short of money, but you should see how much they waste on movies”. Or cars or wine or eating out — or tattoos.

I’ve caught myself at it over the years, and concluded that everyone has different priorities when it comes to spending. You can always find something “unnecessary or extravagant” that another person buys. And they could almost certainly do the same for you.

While tattoos might seem like silly spending to you, they can mean a lot to others. At the same time, the tattooed people might jeer at the money you spend on booze or holidays or whatever. But it doesn’t get any of us anywhere.

Much loved American poet, essayist and journalist Walt Whitman once said, “Be curious, not judgmental.” You might find learning about tattoos enlightening!

AAnd the hats are better…

Thanks for brilliantly making the point that people can jump to any conclusion they like about share investing by picking the right period.

Generally, if you really want to know what’s been going on, the longer the period the better, so that you include both crashes and rallies, preferably several of each.

I fully agree with all your three points at the end of your email.

By the way, another point I should have made last week, in response to the reader worried about US share returns, is that I always suggest investing in a global share fund, not one that includes only US shares — or shares in any other country, including New Zealand.

UPSIDE DOWNSIDE EXCERPT

To mark Money Month, which is this month, the Reserve Bank of New Zealand is updating an online booklet I wrote for them several years ago, called “Upside, Downside — a Guide to Risk for Savers and Investors.”

This week, and over the next four weeks, I will be including excerpts from the updated “Upside, Downside” in this column.

Today’s excerpt looks at the power of paying off debt. In the next few weeks, we’ll look at different types of risky behaviour commonly practised by investors.

The updated booklet is being launched on the Reserve Bank website, rbnz.govt.nz, in September.

The one high-return, low-risk ‘investment’

Pretty much all investments come with some risk. This small book guides you through the different types of investment risk, explains why investment risk is not necessarily a bad thing, and gives tips on how to reduce risk.

Before you launch into investing, though, consider the one financial move that offers what seems to be the impossible: a fairly high return and virtually no risk. It applies if you have a mortgage or other loans, such as credit card or buy now pay later debt. The move: put your savings into paying off debt as fast as possible.

Start with high-interest loans such as credit cards and buy now pay later. Paying off a loan on which you are being charged 20 per cent interest improves your wealth in exactly the same way as receiving an investment return of 20 per cent after tax and fees, with no risk. It doesn’t come much better than that!

Once you’ve got rid of high-interest debt, it’s also good to reduce your mortgage. This is equivalent to making an after-tax return on an investment that is the same as your mortgage interest rate. So if you are paying 6 per cent on your mortgage, repaying it is like earning 6 per cent after fees and tax. This is a deal you won’t be able to beat without taking some risk.

Aside from equivalent returns, repaying debt is good “insurance” against hard times. If you find yourself facing ill health, redundancy or a forced early retirement, having a low mortgage or a mortgage-free home makes it much easier to cope. And if a family member needs financial support, having low debt will make it easier for you to borrow more if necessary.

Repaying debt is also simpler than investing. You don’t have to select an investment or monitor it.

How effective is repaying your mortgage faster than necessary?

Let’s say you have a $200,000 25-year loan, at 6 per cent. If you pay back an extra $50 a month, you will save about $17,500 in interest over the life of the loan, and pay it off two years early. If you repay an extra $200 a month, you’ll save more than $54,000 in interest and pay the loan off in less than 19 years.

For other amounts, interest rates and mortgage terms, use one of the internet mortgage calculators; for example, at www.sorted.org.nz, www.theshapeofmoney.co.nz or www.interest.co.nz. Each site offers different features.

If you receive a lump sum of money, such as an inheritance, bonus or redundancy payment, it’s also a good idea to use that to repay debt — perhaps after using a small portion for fun!

Note, though, that with fixed rate mortgages, there is usually an early repayment penalty. While some lenders permit you to increase your regular mortgage repayments by a relatively small amount without incurring that penalty, most won’t accept large regular payments or lump sum payments without penalty. If you face a penalty, it’s often better to put extra mortgage repayments in term deposits and transfer the money to loan repayment when the fixed term ends.

In KiwiSaver

Despite the above, there have always been good arguments in favour of not putting every cent of your savings into repaying your mortgage, but also investing a small amount — perhaps $50 or $100 a month — into a balanced fund, share fund or similar.

Doing this helps you learn about the way markets work, and gives you a better spread across different types of assets, rather than just your home. Also, you’ve got another investment up and running, which makes it easy to transfer more money to it once you’ve repaid your mortgage.

The introduction of KiwiSaver strengthened this argument. Because of the government contributions, and also, in many cases, employer contributions, KiwiSaver is a particularly good investment. But does it beat mortgage repayment?

That depends on several factors, some of them unforeseeable, such as future returns on your KiwiSaver fund and future mortgage interest rates. But if we make some reasonable assumptions about those, the answer then depends on your employment status, as follows:

• For middle- and high-income employees, contributing to KiwiSaver will probably be better than mortgage repayment. However, you should put in only the minimum 3 per cent employee contribution. Beyond that, put any further savings into repaying the mortgage.
• Lower-income employees will also probably be better off by contributing to KiwiSaver. And if your employee contributions total less than $1,043 a year, it’s worthwhile to make extra contributions to reach that level, so you receive the maximum $521 government contributions. But you should also put any further savings, after that, into mortgage reduction.
• For the self-employed, and beneficiaries and other non-employees — who don’t receive employer contributions — contribute $1,043 a year into KiwiSaver to get the maximum government contribution. Further savings are probably best put into mortgage repayment.

Having said all this, anyone with a mortgage that’s close to the value of their home would probably be wise to concentrate on getting their mortgage down. That puts you in a much more secure position if your income is reduced or your expenses rise in future.

What to do when?

Here’s a suggested order of what to do with your savings:

• A) For those eligible for KiwiSaver (You must be living in this country and either a New Zealand citizen or entitled to live in New Zealand indefinitely.):

1. Pay off credit card and other high-interest debt.
2. Join KiwiSaver.
3. If you have a mortgage, contribute only enough to KiwiSaver to get maximum incentives (see above) and put further savings into mortgage repayment.
4. If you haven’t got a mortgage, your decision on how much to contribute to KiwiSaver depends on your personality and circumstances. If you want to maximise your access to your savings, put only enough into KiwiSaver to get all the incentives, and put further savings elsewhere. But if you like locking away your money so you won’t spend it — and you think it’s unlikely you will need money for other purposes before retirement — put most of your savings into KiwiSaver. It’s probably best if you still keep a few thousand dollars accessible in other investments.

• B) For those not eligible for KiwiSaver:

1. Pay off credit card and other high-interest debt.
2. If you have a mortgage, put most or all of your savings into repaying the mortgage. But consider also putting a small portion into other types of savings, such as a non-KiwiSaver fund.
3. If you haven’t got a mortgage, save through investments such as diversified shares or bonds, managed funds or property.