NZ Herald 4 October 2008

AThanks for reporting back, and providing a positive story to brighten the current gloomy Business pages.

That idea of saving what used to go on your mortgage payments is a great way to build up a retirement fund.

I also like your letter because it shows — at a time when people are panicking and bailing out of share markets — that investments in share funds can be rewarding.

Not everyone will double their money in seven years — which means an average annual return of more than 10 per cent. In fact, it’s quite possible to suffer a loss in shares or a share fund over seven years. But it’s unusual to do so over more than ten years, and really unusual over 20 years, and healthy gains over such periods are common. So I do hope those with longer term horizons stay calm and stick with their share investments.

What if you have less time at hand before you plan to spend the money you’ve invested in shares? Or if the recent wild fluctuations have made you realize you can’t cope with volatile share markets?

A basic investment rule applies here: Don’t sell in panic.

Instead, move out of your share holdings gradually. You might, for instance, plan to sell 10 per cent of your holdings at the start of each of the next ten months or, better still, at the start of the next ten quarters — to string it out over two years or so. If your holdings are quite small, perhaps make it simpler by selling quarter now, another quarter in say six months, another six months after that, and the final holdings 18 months from now.

Why? As always, nobody knows where the markets will go from here. But we might be at the bottom of the trough. You’re going to feel sick later on if you realize you sold all your shares or share fund units at their cheapest prices in years.

But if you sell gradually, you’ll get low prices sometimes but relatively high prices at other times. It’s a much lower risk strategy.

What if you are in a KiwiSaver fund — or any other investment into which you have been drip feeding money — that includes some shares? If you want to reduce your share holding, start by asking your provider to switch any new contributions to a low-risk fund.

That way you won’t sell any shares at the current low prices. And slowly your total portfolio — all your investments — will become less risky as the new contributions grow.

If that’s not enough of a change for you, you could also set up a gradual plan. Ask the provider to move a portion of your current investments to the lower risk fund now, and other portions over time, as described above.

In investment, just as in Aesop’s race between the tortoise and the hare, slow but steady is the winning way.

AOnly for older KiwiSavers on low incomes.

As I’ve said earlier, generally mortgage diversion works well for employees with mortgages, except for some who earn less than $26,075 a year. A rule of thumb is that those people should still use mortgage diversion if they are under 35, but they should skip it if they are over 55. People aged 35 to 55 in that income bracket should use mortgage diversion if they are in a conservative KiwiSaver fund, but not if they are in a riskier fund.

Why the $26,075 cutoff? At that level, someone contributing 4 per cent of their pay is putting in $1,043 a year. And the government tax credit matches member contributions up to that level — but only on money left in KiwiSaver, not on money diverted out to a mortgage.

That means that if anyone earning less than $26,075 uses mortgage diversion, it will reduce their tax credit. That’s not the end of the world. For younger people, diversion is still the best strategy. But for those closer to NZ Super age, the lower tax credit has a bigger impact.

However, all of that assumes the employee is contributing the usual 4 per cent of their pay. It’s a bit different if they are doing “2 + 2” — a KiwiSaver option under which the employer and employee each contribute 2 per cent of the employee’s pay until April 2010. Then they each contribute 3 per cent for a year, and then 4 per cent from April 2011 on — at which point their contributions are the same as most other KiwiSavers’.

That last point is important. Because 2 + 2 is different for only the next two and a half years, it doesn’t greatly affect the mortgage diversion maths for most people. And, I should note here, the numbers are approximate anyway. The results depend on:

• How long you will be in KiwiSaver.
• Assumptions about mortgage interest rates and the returns on KiwiSaver funds of different risk levels, all of which change frequently.

Nonetheless, if you are contributing just 2 per cent of your pay to KiwiSaver and you use mortgage diversion, you will be affected more by the reduced tax credit.

Already — even before mortgage diversion — people on 2 + 2 receive a lower tax credit if they earn less than $52,150.

For example, someone earning $25,000 and contributing 4 per cent of pay, or $1,000, gets a $1,000 tax credit. But if they contribute 2 per cent, or $500, they get a $500 tax credit. And someone earning $50,000 and contributing 4 per cent, or $2,000, gets the maximum $1,043 tax credit.

But if they contribute 2 per cent, or $1,000, they get a $1,000 tax credit.

Add mortgage diversion to the mix, and anyone on 2 + 2 earning less than $104,300 is affected.

On $100,000, their $2,000 contribution will be halved with mortgage diversion to $1,000, so their tax credit will drop from $1,043 to $1,000. And on $50,000, their $1,000 contribution will be halved to $500, so their tax credit will drop from $1,000 to $500.

Still, because the lower 2 + 2 contribution levels last only a couple of years, they don’t make a huge difference to people who will be in KiwiSaver for decades.

Crunching numbers suggests that we should stick with out $26,075 cutoff, stating that every mortgaged employee earning more than that should still be better off using mortgage diversion, even with 2 + 2.

But for those earning less than that, we should change the age from 55 to 50. The 2 + 2 rule of thumb, then, is that people on less than $26,075 should still use mortgage diversion if they are under 35; they should skip it if they are over 50; and in between they should use mortgage diversion if they are in a conservative KiwiSaver fund, but not if they are in a riskier fund.