Buying a first home is a proud moment but then comes the hard part of paying down the debt. Photo / Getty Images
OPINION
Q: As a young man, I’ve read your articles over many years and really valued your advice. Recently my family completed a house build and, on top of now having a larger mortgage, we have used around $45,000 of our line of credit. We currently have that charged at floating rates. I also have $15,000 in a Simplicity aggressive fund and I pay $100 a week into it. Having worked out my family’s budget, we can pay down the $45,000 by about $25,000 per year conservatively. My question: should I stop investing $100 per week and put that against my loan? Or more extreme: should I withdraw my $15,000 and dump that into the loan? I’m a bit reluctant on that as recently the market is not great so I want to leave that $15,000 untouched. I saw a clip online where someone said to go whole hog on paying down a loan as it’s more of a mental hurdle to overcome, even if mathematically it doesn’t balance out.
A: That must be exciting, moving into a newly created home. But you’re right - now’s the time to work out how best to pay for it.
Your question boils down to a classic investment issue: to pay down debt or invest?
There are two things to consider:
· Which is higher, the interest you’re paying or the expected return on the investment?
Your wealth equals your assets minus your debts. Reducing debt with, say, 6 per cent interest improves your wealth in exactly the same way as earning 6 per cent, after fees and tax, on an investment.
In your situation, though, the future return on your aggressive fund is impossible to know. You might double your money in just a few years, or your balance could drop in a market slump.
Meanwhile, interest rates on a line of credit are never low. So there’s a pretty good likelihood that the interest will be at a higher rate than the after-fees and after-tax return in the fund. If I were you, I would stop your $100 weekly fund contributions and put that money towards reducing the debt.
What about withdrawing the $15,000 to cut the debt further? I like the idea. I can understand your reluctance, given market returns, but they have improved considerably since you wrote to me. If you are still concerned, though, you could withdraw $5000 a month for three months, to spread the risk.
· Psychological issues. I agree with what you saw online. Most people feel more comfortable reducing debt than adding to savings. For one thing, it gives you more options in the future.
So I suggest you do whatever you can to get rid of the line of credit quickly.
Then comes the next question: once that debt is gone, should you restart the $100 a week into the fund, or use that money to reduce your mortgage?
The mortgage interest will be lower than on the line of credit, so it’s not so pressing to reduce that loan. While it’s still really good to get rid of your mortgage fast, I like the idea of continuing to make small regular savings at the same time. It gives you diversification and you learn about the markets.
Q: I’ve taken on board the advice of yourself and others to invest in passively managed index funds rather than actively managed investments.
However, recently I saw that the New Zealand Super Fund acting chief executive said in the Herald that they’ve earned $16 billion more with active strategies than if they had used an index-linked portfolio.
Does that call into question the belief that active managers don’t generate better returns over the long term?
A: Gosh! Will my long love affair with passive investing end?
What are we talking about here? When you invest in a medium to higher-risk KiwiSaver or other managed fund, the manager selects the shares you are investing in.
Passive funds simply buy all the shares in a market index, whereas active fund managers choose which shares to buy and sell and when to trade them.
Passive funds are cheaper to run, so their fees are lower. And while they aren’t usually the top performers in any period, they are also not the bottom ones. Over the long term, with their steadier performance and low fees, they tend to be a better bet.
Enter the New Zealand Super Fund - set up by the Government to build up a huge block of money to help fund New Zealand Super payments in the future.
The fund reports that over the 20 years since it started investing in 2003, its return was 9.53 per cent a year, compared with 7.93 per cent for its “reference portfolio”. The reference portfolio shows how the fund would have performed if it had invested passively, with 75 per cent in global shares, 20 per cent in fixed income, and 5 per cent in New Zealand shares.
But that victory for active investing doesn’t change my preference for passive funds for several reasons:
· The Super Fund has a very long investment horizon, with the first withdrawals not expected until next decade and no substantial withdrawals until the 2050s.
That enables it to invest in illiquid assets - which can’t be bought and sold quickly - such as infrastructure, private equity and timber. These can be great long-term investments and add diversification, but they wouldn’t work well in a fund from which people are regularly withdrawing money.
The long horizon also means the fund can - and should - invest in riskier assets that tend to have higher long-term returns but can be very volatile in the short term. It has the ability to “ride out short-term market movements”, according to its website.
· The Super Fund is huge - at about $70 billion - compared to, say, a KiwiSaver fund. All the KiwiSaver funds put together total about $100 billion, so each fund is way smaller than the Super Fund.
This means the Super Fund managers would get much better deals on fees and expenses. And they can “undertake extensive due diligence and manager monitoring to ensure [they] choose the most effective and skilled investment managers”.
· While the Super Fund has performed well - which is great given it is investing taxpayers’ money - so far the figures are for 20 years. That’s a respectable amount of time over which to judge a fund’s performance, but it’s not long enough to change my mind!
I’ve been watching active and passive investment since I first learnt about - and invested in - index funds in Chicago in the 1970s. Research by organisations like S&P Global keeps showing that most active funds perform worse than index funds. And the longer the period looked at, the more active funds tend to underperform.
Still, there are nearly always a few active funds that do well over a decade. How do they perform the following decade?
One paper looks at the five US share funds that Morningstar nominated as fund manager of the decade in 2010, after they had done way better than the market index since 2000. In the following decade, all performed below the market index.
Over the long term, I’m still convinced that, for the likes of you and me and the funds we can invest in, passive tends to be better.
Even the Super Fund - which uses both active and passive management - acknowledges that “the ability to consistently generate excess returns from skill versus an appropriate benchmark (net of fees) is rare; where this ability exists, it is hard to access”.
Q: I felt that the chauffeur letter last week was a dig at and offputting to people who were in a healthier position for retirement but still had concerns and wanted someone to ask.
Is your financial column only for those below a certain level of wealth? If so please publish those parameters. I’m interested in the demographic of your readership. I would suspect being Herald readers that a fair proportion would be in a similar situation to myself.
Yes, I’m comparatively well off: two investment properties mortgage-free, valued at $600,000, each returning $20,000 after tax. We rent ourselves, but that has increased from $500 a week to $800 since Covid. This is fine while both working and earning over $1000 a week. But a huge lifestyle change to retire. So yes, we also are stressed about our futures.
Please don’t forget that there are people out there that have worked long hours all their lives. They may have done a lot of the things you recommend and are now comparatively well off. They are still entitled to have concerns over safeguarding their retirement.
They shouldn’t be concerned that asking you for your opinion will lead to public trolling.
A: I’m sorry if that Q&A offended you - although it was hardly a public trolling, given letters in this column are anonymous.
In answer to your question, my column is for everyone. I tend to get more letters from wealthier people, but I encourage others to write too, in the hope that my suggestions might make a difference to their wellbeing.
By the way, you didn’t do this, but some people who attribute their wealth to hard work imply that poorer people don’t work hard. What about the South Auckland families in which both mum and dad work two jobs?
It seems to me there’s also a lot of luck in financial success, whether it be in upbringing, intelligence, skills, “who you know”, inheritances or lucky market timing with property or shares.
Another reader also disliked that Q&A, writing: “You undercut the cachet of your column when you publish a letter from someone who is clearly taking the piss.” But read on.
Q: The “paying the chauffeur” Q&A was my first belly laugh of the day. Glad you put this one in, so much doom and gloom nowadays.
A: I thought it was fun too. And another reader wrote: “LOVE your response.”
You can’t please all of the people all of the time.
Q: You say in last week’s column that you don’t like people using a loophole in tax law to cut their taxes in a way not intended by the Government. But how do we know what the intentions of the Government are? (Surely you wouldn’t presume to bestow upon yourself that privilege of determining that on behalf of the rest of us?) Luckily we do have a more authoritative expression of the intentions of the Government and that is statute law, as interpreted by the courts. If the Government of the day finds that a provision in tax law is not operating as they wish, they can change the law to fix that and in New Zealand that can happen within a single day if Parliament sits under urgency. Until that happens, the law is the law and taxpayers may use any concession that is available and are not open to any valid criticism for doing so. I will add that in your campaign against “loopholes” you appear to overlook that New Zealand tax law already contains a strong anti-avoidance rule (section BG1) that effectively overrides other provisions of tax law to deny the benefits of an arrangement when a more than incidental purpose of the arrangement is to obtain a tax benefit.
A: Thanks for your expertise on this. The system sounds good, but we do still hear of people doing fancy footwork around tax law. And I disagree that criticising that behaviour is not valid.
But enough on this. We’ll just have to agree to differ.
* 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 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 mary@maryholm.com. 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.
Demand for bonds may well stay strong, but there's a catch.