Mary Holm: Can a keen young saver borrow to invest?

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OPINION:

Q: I am just about to finish your book A Richer You, and I wanted to ask for some advice. I love investing and at 20 years old I have a total of $20,000 across a Vanguard S&P 500 ETF and a smaller amount in New Zealand in the top 50 Smartshares fund.

What else can I do to get more financially ahead in my twenties? Maybe what you would have done if you could go back to the start of your twenties?

P.S. I already have my KiwiSaver in a low-fee growth fund :)

A: Wow. 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 10 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.

The 10-year plan

Q: Can I just comment on the 10-year stock holding timeframe you've been writing about? Suppose one has invested in a basket of shares with an eye to a comfortable retirement, and nine-and-a-half years later, after the market's ups and downs, you are rewarded with a final up. One is then ready to cash in, using the funds in a measured way to enjoy one's last years.

And then the market crashes heavily before withdrawal of funds at 10 years. It could take eight years, as pointed out, to recover to even a fixed interest investment level. One may not have such time available, and certainly would have to forgo the comforts or bucket list one has so diligently and patiently waited for.

So, in the end pure luck and chance is the final determiner, is it not?

A: No! 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 10 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 10 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 sharemarket 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 10 years to play with.

By the way, while some people say 10 years is too long for the 10-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.

Beyond Bonus Bonds

Q: Like many others, we deposited funds in a Bonus Bonds account in our 11-year-old great-grandson's name.

With Bonus Bonds being wound up, we will receive a refund of over $1000. What should we do with the funds? We are leaning towards a KiwiSaver growth fund in his name. What is your opinion?

A: That'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 service.

Tax and KiwiSaver

Q: I have two questions in regard to KiwiSaver:

• Do I have PIR tax to pay while my KiwiSaver account is earning a negative return (making a loss)?

• If a KiwiSaver member is turning 65 on 30 May next year, if he can only make a lump sum contribution after he makes a retirement withdrawal on 15 June, will he receive the government contribution? Or does the contribution have to be in the KiwiSaver account prior to his withdrawal?

A: On 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.

Cheap wine rules, okay

Q: Mary, we took your advice last week, examined our finances and concluded we were comfortable. So we promoted ourselves from an anonymous box wine to a named variety. Didn't like it. Tried another named variety. Didn't like that either.

So now we are back to the pleasant familiar, but now occasionally open a bottle of something special (2020 and 2021 rosés are very pleasant.)

A: Excellent! 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.

Spreading the risk

Q: I agree with your comments last week about the person wishing to invest in fossil fuels in Taranaki. Another argument should be invoked around diversification.

One should not be overly reliant on holding shares in a company in which one is employed. If the company fails, then you lose your job and investment.

Similarly, if you are in a region that is dependent on a particular industry, then you should invest in other industries, in case both the local economy and your investment fail. Of course Taranaki has other industries, such as dairy and tourism, although the latter is also in the doldrums, but the principle remains.

A: Fair 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.

- 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.