Beyond the bank

By MARK FRYER

By most standards, $51 billion counts as rather a lot of money. That's how much New Zealand "households" (as opposed to businesses, government and other organisations) have sitting in the bank.

And Reserve Bank figures suggest the vast majority of that money is doing just that - sitting - in cheque or savings accounts, or in relatively short-term deposits.

For the owners of all that cash, security presumably ranks more highly than chasing the best possible returns.

But what if you want to make your money do more? Where can you go without risking everything?

While investment advisers preach the gospel of shares and long-term capital growth, that's not a message many investors are interested in hearing right now.

But there are ways of making that $51 billion work a little harder. They may not be exciting, but after the past few years that's the least of anyone's worries.

Repay debt

That $51 billion in the bank is only one side of the ledger; at the same time, households also owe the banks more than $80 billion. Some have nothing but debt, and no money in the bank; others have the money and no debt.

But if you're in the group with some of each - debt, but some money too - your best investment is staring you in the face.

Paying off a mortgage at, say, 7.5 per cent is the same as putting your money into an investment that pays 7.5 per cent - after tax and with no risk. The return is even better if you're paying off a credit card with an interest rate of 18 to 20 per cent.

For: Simple, rewarding, no risk.

Against: Your loan may not allow extra payments, or may impose a penalty. With some loans, once you've made an extra payment you may not be able to get at that money if you need it later.

Bank term deposits

No, the rates aren't anything to write home about. But even after tax, a term deposit will at least stop your money from being eroded by inflation. And however low the rates may be, they're better than nothing, which is what you may be earning on a cheque or savings account.

You'll typically get slightly more if you're prepared to lock up your money for longer - say 5.9 per cent a year for $10,000 invested with one of the big banks for five years, compared with 5.4 per cent for six months.

If you don't know where interest rates are going - and no one does - splitting your money into several deposits, over different terms, will at least smooth out the ups and downs.

For: About as easy as investment gets.

Against: Typically, you can't get your money out early, or may face a penalty if you do.

Finance companies

Higher returns than the banks, but less certainty. Finance companies range from well-established institutions with strong assets to those that are much less strong.

The old rule - higher return means higher risk - is a guide, but only a very rough one. Remember that terms such as "guaranteed" or "secured" are only as good as the institution offering the guarantee.

For: Simple, better returns.

Against: Hard to judge the risk involved, you may not be able to get your money out early, or may face a penalty for doing so.

Government stock

The ultimate in security, government stock offers relatively modest returns - somewhere between 5 per cent and 5.9 per cent at present (apart from 13-year stock, which is only returning 3.5 per cent or so).

This doesn't work like a bank deposit; instead of handing your money directly to the Government, you buy existing stock on the "secondary market".

Similarly, if you want to get your money out early, you sell your stock on that market.

Stockbrokers, banks and investment advisers, among others, can help with those purchases or sales.

If you hold the stock until its maturity date, you will get the return you expected at the outset. If you sell out early, there's no penalty, but you have to accept whatever the market is offering, which may mean a profit or a loss.

As a rule, you'll need to have about $10,000 or more to invest.

For: Security, wide range of terms available, possible profit if you sell before maturity.

Against: Possible loss if you sell before maturity, somewhat inflexible - you can't sell, say, $500 of stock if you need some extra cash.

Corporate bonds

These work in the same way as government stock. Returns range from about the same as government stock - for the most secure bonds - up to 9 per cent or so.

Unlike government stock, investors with relatively modest amounts may be able to buy corporate bonds when they are first issued, as well as buying later on the secondary market.

Another difference is that security can't be taken for granted. The return offers a guide - higher return and lower security go hand in hand - as does the credit rating which some bond issues carry.

Again, investors who get out early may make a profit or a loss.

There are also various permutations on the theme, such as capital notes, which come with different conditions to a standard bond issue, and sometimes offer much higher returns.

For: The strongest bond issues are very secure, possible profit if sold before maturity.

Against: Can be difficult to judge how secure a bond is, possible capital loss if sold before maturity, investors need to understand the conditions attached to things such as capital notes.

Managed funds

As well as the familiar unit trusts and other types of funds that invest in the sharemarket, there are a multitude of funds that put investors' money into lower-profile (but lately more rewarding) areas.

These include cash funds or cash management trusts, short-term homes for money you want to keep on call, fixed interest funds, which invest in government stock and corporate bonds, and mortgage trusts, which lend investors' money to property buyers.

Property trusts could also be regarded as belonging to this lower-risk, lower-return family of funds.

Investing this way provides the usual advantages of managed funds - you can spread your money around so you're not relying on just one investment, it's convenient and easy to invest or withdraw small amounts. It may also be possible to automatically reinvest your earnings.

For those advantages you pay fees and, with returns as low as they are, a fee of 1 per cent or 1.5 per cent a year can take a big bite out of your returns.

As well, the returns on managed funds are not as predictable as they are with direct investment.

If you buy government stock, for example, the value of your investment may fluctuate, but if you hold it to maturity you'll get the return you expected. But with a managed fund that invests in government stock, the return may fluctuate.

Before investing, it can be worth looking at how a fund is taxed - some managed funds can deduct tax at the individual investor's rate rather than the standard 33 per cent, which is an advantage for investors in the 19.5 per cent bracket.

For: Convenience, diversification, small initial investment, possibly automatic reinvestment.

Against: Fees, returns less certain than direct investment.

Shares

Yes, shares. While many investors have given up on the prospect of making quick capital gains on their share investments, there are shares which pay dividends much higher than you'll earn at the bank.

They're not as certain as a bank deposit, but that's the tradeoff.

David McEwen, managing director of sharemarket research company Investment Research Group, says 8 per cent is a reasonable return to expect on a portfolio of New Zealand shares chosen with an eye to income.

"Because shares are out of favour you can get some very good yields," he says.

Choosing those shares is a little more complicated than running your eye over the newspaper share tables to find those that pay the highest dividends.

The numbers in the table are historic - they may include special payments which won't be repeated, and the company's ability to pay a dividend may have changed.

And published dividend figures - including those in the Herald share tables - typically include imputation tax credits, which effectively make many dividends tax-free.

However, those credits can only be used to reduce tax on other income; if you don't have much other income, you won't be able to take full advantage of those credits and the return on your share investments will be reduced.

For: Attractive returns, easy to sell at any time, chance to make a capital gain as well as earning income..

Against: Paperwork, yields aren't guaranteed, shares' value could fall, even if the yield holds up.

* To contact Personal Finance Editor Mark Fryer write to: Weekend Herald, PO Box 32, Auckland.

* Email Mark Fryer. Ph: (09) 373-6400, ext 8833. Fax: (09) 373-6423.