Rule of thumb gives borrowers an easy way to work out how deep into the red they're going. Photo / 123RF
OPINION:
Q: Riffing off your recent comments regarding compounding, you might give your readers a quick lesson on the Rule of 72.
As the rule is traditionally invoked, you use it to find out how long it will take to double your investment under various interest rate regimes.
Nonetheless, I have never seen in print the way the rule can be used to calculate how long it will take to double your debt under various interest rates. Exhibit A is, of course, credit card debt. The numbers are truly appalling.
A: Hang on a minute! Back in December 2006 I wrote in this column that the Rule of 72 is "a handy little trick. It goes like this: if you want to know how many years it will take for an investment or a debt to double, with compounding interest, divide the interest rate into 72.
"Examples: at 4 per cent, it will double in about 18 years. At 12 per cent, it will double in about 6 years."
So I did include debt back then! I admit, though, that I don't always do so when writing about the rule. And it's a really good point. With some credit card debt at 20 per cent, you can divide 20 into 72 to find that the debt will double in about three-and-a-half years.
Appalling indeed.
There are two other uses of the Rule of 72: if the value of an investment or debt has doubled, you can work out the annual return or interest rate on it by dividing the number of years it took to double into 72.
If it took 9 years for your house value to double, your return is about 8 per cent a year. If it took 5 years for your debt to double, you're paying about 14 per cent in interest.
And if you want to know how long it will take for inflation to halve the value of, say, $100, divide the inflation rate into 72.
If inflation is 2 per cent, it will take about 36 years for the value to halve. If inflation is 5 per cent, it will take about 14 years.
These are approximations, and they work best for returns between 3 and 20 per cent. If, for example, your house value doubles in two years — which has occasionally happened — the Rule of 72 says you received a return of 36 per cent a year. But an online calculator tells us it's more like 41 per cent.
Note that the rule works only if you invest or borrow a lump sum, not if you dripfeed, as in KiwiSaver.
One of its beauties is that you can divide 72 by 2, 3, 4, 6, 8, 9, 12, 18, 24 and 36, which makes calculations easier. And for other numbers, near enough is good enough.
Q: I was very very interested to read last week of the two friends who had had a flutter with Bonus Bonds for 10 years and earned $380 in that time from an investment of $3265.
I have, until last month, had $10,000 invested in Bonus Bonds for the same length of time and earned a measly $120. Really poor return but I kept hoping for the "big one"! So naive.
Needless to say, I cashed in all my bonds prior to the last draw and have invested in a term deposit, which I am hopeful will give a better return.
A: But there won't be any excitement. If you want to keep the party rolling, read on.
Q: In your last column, a reader said they enjoyed the fun of Bonus Bonds. You asked if anyone could think of another investment where they could win big but not lose their money.
By owning Bonus Bonds, the reader was giving up earning interest in return for a gamble on a big win. They can continue to do that — they just need to put their money in term deposits and spend the interest on Lotto tickets.
Put simply, Lotto pays out 55 per cent of its revenue as prizes, while the average Bonus Bonds return was less than half the typical term deposit rate for the last few years.
The reader would have a higher average return than Bonus Bonds; they stand to win much larger sums; and the profits would go to the community rather than ANZ.
It wouldn't be automatic like Bonus Bonds, but the extra engagement would only add to the fun.
A: Brilliant! People often compare Bonus Bonds and Lotto, but the big difference is that with Lotto you don't keep the money you put in. But with your plan you would.
Q: I would like to give you my experience of the ANZ and Bonus Bonds. I took these out for our 12 grandchildren approximately 10 years ago.
Instead of giving them a Christmas present, we put about $120 each year into each of their accounts. In some cases it has been very helpful to them when they needed some funds for something special, like buying an engagement ring.
Now that ANZ is terminating the funds, I gave the bank the 12 folders with all the grandchildren's info and a list of their bank accounts so that the bank could transfer to each of their accounts.
But oh no, this is too simple. They want each grandchild to present themselves to the bank and fill out forms. This is difficult as they are studying or the branches are open only two days a week.
Not many of the children — maybe one who wanted to take some money out — has ever been into the bank and never did when I opened their accounts.
All ANZ has to do is transfer the funds to their accounts, but being a bank that has not gone into the 21st century, they are demanding all this nonsense.
Being a businessman with considerable companies, and used to remitting funds all over the world, I find their actions totally archaic. Many years ago we stopped any ANZ accounts we had.
A: I understand your frustration. But I can also see the bank's point of view.
An ANZ spokesperson responds: "Depending on the particular customer circumstances there can be a number of reasons that your writer was unable to redeem the Bonus Bonds on behalf of his grandchildren.
"One reason is that minors gain control of the Bonus Bonds purchased for them as gifts when they turn 15, and therefore we need to take our instructions from them as they are the owner of the units.
"Another possible reason is if we needed to identify the customer to meet our anti-money laundering obligations," he says.
My take: If some of your grandchildren are old enough to buy engagement rings, they are old enough to run their own finances — as the bank's practice for 15-year-olds acknowledges.
And, of course, if they've never been into the bank, the Anti-Money Laundering and Countering Financing of Terrorism Act kicks in. And "kick" is the right word. There can't be many adults who haven't been inconvenienced by that act — having to turn up in person to prove who they are.
But presumably the act does stop some bad stuff happening. As the Reserve Bank puts it, the act "seeks to contribute to public confidence in New Zealand's financial system and bring New Zealand into line with international standards to detect and deter money laundering and terrorism financing". In any case, ANZ has to follow the rules.
Perhaps you could look at it this way: the grandchildren are really lucky to get this money.
If, in the process, they have to learn a bit about how "the system" works, that's life.
Q: Me and my wife are both 62 and it's just me working.
Term deposit rates are very low at the moment, so I'm thinking of putting a recently matured TD ($190,000) into my KiwiSaver balanced fund, which has averaged around 5 per cent a year over the long term. My KiwiSaver fees are 1.04 per cent a year.
Apart from fluctuations in the KiwiSaver investment, are there any pitfalls that I need to consider?
A: Whenever one investment pays a higher return than another, you can guarantee it will be higher risk.
In a widely diversified KiwiSaver fund there's virtually no danger you would lose all your money. But the risk is — as you point out — volatility.
There are two questions to ask yourself about volatility: can you cope when your balance drops, and be willing to wait — possibly for a few years — for it to recover? Or will you panic and move your money to lower risk at the wrong time?
When do you expect to spend the money? If it's within about three years, it would be better to put it into a low-risk KiwiSaver fund, or stick with your term deposits. You don't want the balance to drop close to spending time.
But if that's all good, your idea seems fine. Lack of access to the money is probably not a big deal for you, as that will change when you turn 65.
Just be aware, though, that your return could easily be lower than 5 per cent in future, and sometimes negative.
Q: I am a 63-year-old single nurse currently working in rural Australia to make some extra money to pay off my mortgage at 65.
I currently have $34,000 in an Australian super fund and a similar amount in KiwiSaver. I am watching my balance trend down in Australia and trend up in NZ — slowly at present, after a loss of $5000 in both accounts initially.
Should I withdraw the Australian balance and transfer to KiwiSaver, consolidating both, or leave it separate in the two funds?
I don't have any other savings, and the mortgage payment is important to me. I hope to work till 67. Please give me some advice as it is a worrying situation.
A: Nobody, not even the experts, can say whether your Aussie or New Zealand fund will do better from now on. What they've done lately is no guide.
So it's lower-risk to have some savings in each country, rather than choosing one, only to find you made the wrong choice!
Having said that, if you are worrying about it all, that suggests you are in funds that are riskier than you can cope with. So perhaps you should gradually move to lower-risk funds with the same providers. They will grow less, on average, but there will be fewer ups and downs.
Ask the providers how to do that. It should be easy.
- 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 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.
The Reserve Bank will this week deliver a new set of forecasts for where rates are headed.