Kill debt or keep invested?

QI’m in my mid-forties, with the mortgage on our family home about $150,000 remaining. Our other assets — in various states of liquidity across shares, index funds, crypto, classic car — are also about $150,000.

I typically deposit $1,000 a month into the investments (mainly the index funds these days, crypto and classic car are from my crazy thirties!). And over the last 10 years, when money was cheap and shares were roaring, this seemed to pay off.

However, at current interest rates, I’m paying $1,000 a month in interest only. It seems I should cash everything up, pay off my mortgage, and then I’d be $1,000 month better off.

Obviously my investments would start from zero, and this dramatically removes diversity from my portfolio, but being mortgage-free and having another $1,000 a month seems mathematically correct. What am I missing here?

ANote to all readers who think this Q&A doesn’t apply to them: Many readers’ questions come down to this basic issue. If you have investments as well as debt of any kind — from high-interest to student loans — should you sell the investments to reduce the debt?

There are several factors to consider:

  • Is the interest on the debt higher than the likely return — after tax and fees — on your investments? If it is, pay off the debt.

    This assessment is easy if you have credit card or similar debt, on which the interest is almost certainly higher than investment returns. It’s also easy if you have an interest-free student loan. It’s better to just repay the amount taken out of your pay — unless you plan to go overseas, when you will pay interest on the loan.

    But in situations like yours, it’s tricky, because we can’t predict your investment returns. You should, though, take into account that paying down your mortgage is like having a risk-free investment giving you whatever the interest rate is. These days, that’s pretty attractive.

  • Diversification. You rightly say that if your home is your only investment, you lack diversification. Because of this — and also because it’s good to learn about market fluctuations over the years — I recommend having at least a small investment in, say, a low-fee share fund. And that’s especially true if it’s a KiwiSaver fund.

    You don’t mention KiwiSaver, but it’s a pity not to be in it, even if you have a mortgage. The government contribution makes it an investment that’s hard to beat. And if you get employer contributions as well, it’s really hard to beat.

  • Security. Paying off debt improves your security. You’ll no longer suddenly face big interest rate rises. And if you’re debt-free and get into financial strife in future, you can probably borrow again against your house, or raise a personal loan.
  • Psychological issues. Many people simply prefer to be without debt — even a student loan. I respect that. And it’s certainly a great feeling to pay off a mortgage.

    On the other hand, sometimes we invest more than just money into an asset. If you love some artwork or, in your case, your classic car, perhaps keep it.

    How does this all add up for you? I suggest you sell most of your assets and kill most of that mortgage. But keep, say, $30,000 in index funds so you’re in the share market. And join KiwiSaver, depositing at least $87 a month to get the maximum from the government.

    Then put the money that currently goes into investments into reducing the mortgage fast. Talk to your lender about how this can be set up.

    Once the mortgage is gone, it will be great to boost your investments regularly again. And maybe spend a bit more on fun.

Footnote: Whenever you sell investments of more than trivial value, it’s a good idea to spread the selling a bit — say one third now, one third in a month and one third in two months. That prevents you from selling the lot right before a market surge.

When to stay and when to go

QMy mortgage is coming up for refixing mid-year, and I’m trying to decide if I should cash in my broad market exchange traded funds (ETFs) (last I checked they were all “in the green”) to pay an additional lump sum off my mortgage. I wonder if, long term, it would make more sense to leave the shares/ETFs as they are — keeping the benefit of “time in the market” in mind.

The current returns are greater than the mortgage rates, yet I’m also aware that returns can change (unlike the mortgage rate which will be fixed for a period at these higher rates).

I’m in my early 40s and only recently joined KiwiSaver because I was living overseas. I’m conscious that if I go down this route I will only have a small KiwiSaver balance and the rest of my money will be tied up in an equally small apartment that is (currently) worth less than the mortgage. I bought off-plan right before the prices dropped.

AToday’s first Q&A should help you. But there are some other issues here too.

Your comment about “time in the market” probably refers to last week’s first Q&A, when I said it’s best to stick with your investments through thick and thin. Now I’m saying, “Perhaps not, if you have debt.”

Sorry if that’s confusing. Last week I was talking about not trying to time when to get in and out of the markets. But this week it’s not about market movements, but whether you have debt, with interest possibly eating away at your wealth more than your investments are adding to it.

If I were you, I would whack a chunk off your mortgage. You’ll still be in the markets through KiwiSaver. And the sooner you get rid of your debt, the sooner you can seriously build your retirement savings.

A couple of other points:

  • When you say your investments are all in the green, I assume you mean as opposed to in the red — now worth less than you paid for them. This is a common concern, but it shouldn’t have any effect on a decision about selling. The question should be: Are you better off holding those assets at their current value, or using the money elsewhere? The history is not relevant.
  • You’ve had rotten luck with the value of your apartment. But, again, try to forget what you paid for it. It’s your home now, and anyway its value is sure to increase over time

Different family providers?

QIs it better for a couple to have KiwiSaver in two different providers? Is it more risky to have the same provider? Just wondering if there is a kind of diversification in having them with different providers.

AIt’s a fair question, given how much I rave on about the importance of diversification. But I don’t think family members need different providers. The chances of any provider going under and investors losing money are tiny.

On the other hand, it does give you a chance to compare the fees and services — including communications — offered by various providers. So you could go with different ones until you work out which you prefer, and then all switch to that one.

Bitcoin and gold tax

QI’m a chartered accountant running a small practice in the Auckland region.

Last week you had a letter about taxing bitcoin gains, and why they are taxable even if they’re held long term.

The tax approach is the same with gold. In both cases there is no “income” type return as you hold these investments, compared to bank deposit interest or rent on an investment property. The only way you get any return is to sell the gold or bitcoin.

Therefore any realized gain is taxable, and this only happens when you sell. You aren’t taxed on unrealized gains ie the value could go up and down while holding. So the IRD see the only purpose of buying, holding and then selling such assets is to make a taxable gain.

Hope this helps readers understand the reasoning and equity of this treatment.

ALast week’s Q&A wasn’t really about bitcoin, but taxes on capital gains more generally. But anyway, you’ve clarified the situation for bitcoin and gold, so thanks very much. More on capital gains tax next week.

Creepy tax brackets

QYour advocacy of regular adjustment of tax brackets for inflation is spot on. This would remove the Government’s temptation to let inflation increase income tax revenue without being accused of “putting up taxes”.

In the US federal tax system, which has seven brackets as opposed to our five, the brackets are adjusted for inflation annually. For example in 2023, a rate of 12 per cent applied to income between $11,001 and $44,725. For 2024 this has been adjusted for inflation of 5.4 per cent, to $11,601 to $47,150.

I see no good reason to adjust the figures to the nearest thousand dollars, except perhaps to satisfy the strong instinct some of us seem to have to round figures up or down.

AYou’re referring to a paragraph in the April 13 column, in which I said, “By the way, tax rates on wages and salaries are not adjusted for inflation either. The cutoff points between the rates — for example the $48,000 of annual taxable income, above which the tax rate changes from 17.5 per cent to 30 per cent — should be regularly inflation-adjusted.”

New Zealand’s tax rates were last set in 2010 — apart from some more recent changes to just the top bracket. And since 2010, wages have risen 64 per cent, averaging 3.7 per cent a year, according to the Reserve Bank’s inflation calculator.

As people’s wages have risen, they have moved into higher tax brackets. But a big component of their pay rises has just helped them keep pace with inflation. This is sometimes called bracket creep.

Our tax brackets will change on July 1. In our example above, the $48,000 cutoff point will rise to $53,500. With the changes, taxes for everyone with taxable income over $14,000 — not just from wages but also interest, rent and so on — will decrease. But not enough to make up for bracket creep since 2010.

And at this stage there are no plans for annual inflation adjustments, as happen in the US as well as in 11 out of 27 European OECD counties, according to Tax Foundation Europe. Also, Germany adjusts at least every two years. And in some countries there’s no need, as they tax all income at the same flat rate.

In a recent New Zealand poll on NZ tax rates, “67 per cent of respondents supported inflation adjustments, while just 13 per cent were opposed. The remainder were unsure,” says the Taxpayers’ Union, which commissioned the poll.

“There was majority support across every demographic (gender, age, area, economic status, and preferred political party) with the exception of Te Pāti Māori voters, where there was still a plurality of support.”

It would be great if the Government introduced annual adjustments. The trouble is, more money for us means less in government coffers. Still, it seems only fair. Surprise us, Government!

Your last sentence refers to my comment two weeks ago that inflation adjustment should not be to “some amount like $51,342.78! The nearest $1,000 would be good.”

In your US example, it seems they round to the nearest $25. But even that makes it harder to follow. We want our tax system to be as easy to grasp as possible, not just for the likes of you and me but for people who just don’t like numbers.

The new tax rates from July are 10.5 per cent up to $15,600, 17.5 per cent from there to $53,500, 30 per cent from there to $78,100, 33 per cent from there to $180,000, and 39 per cent after that.

While our current brackets are rounded to the nearest $1,000, the new ones are rounded to the nearest $100. Please let’s not go any further than that. People who lose a smidgeon from rounding one year will gain from it the next year.

P.S. In this column you will often see that I suffer from your “strong instinct some of us seem to have to round figures up or down.” Research shows rounded numbers are much easier to absorb over your Saturday morning coffee. In situations where precise numbers are important, I use them. Otherwise, clear communication wins!

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Mary Holm, ONZM, is a freelance journalist, a seminar presenter and a bestselling author on personal finance. She is a director of Financial Services Complaints Ltd (FSCL) and a former director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to [email protected] or click here. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.