Money Matters: House-rich and cash-poor can be silly

By MARY HOLM

Q. I am not very good at this writing lark and have not written to a paper before, and I can manage my affairs, but why not give you a go?

I am 66 years old and the wife is not far behind. We have a house mortgage-free that is valued at $200,000. We live off a Government pension that will cover our food, rates, insurance, power, phone, doctor, Herald and a small bit of pocket-money.

Now we do like a bit of luxury, as we don't know how long we are going to be reading the Herald, so I will put the luxuries in some kind of order:

Overseas holiday once a year, $5000; running costs for his and her cars; a meal out with a bottle of wine twice a month; Sky Digital; a couple of handles down the pub (me only) each night; and a few other things. Total luxuries $10,000 a year.

Now I have worked out that if we sell the house and invest the $200,000 - to keep it simple at, say, 8 per cent, which is 6 per cent after tax - and if we pay rent at $7000 a year, we have $200,000 plus interest of $12,000, minus rent and luxuries of $17,000, equals $195,000.

We would reduce the capital each year, so in 10 years we should be left with $134,000.

I realise that interest rates may drop, and rent and our luxuries may increase.

At the moment we have $10,000 in shares, $10,000 in bonus bonds, $10,000 in bank deposits and $10,000 in other investments. So in four years this will be gone. We sell the cars, no holidays, no Sky TV, just watch Channel 1, 2 and 3. No way.

So what do you think about selling and renting? Or is there some other way? I am sure there are other couples in the same position as us.

A. You're right, there are thousands of retired people like you who are house-rich and cash-poor. It's silly.

Various financial institutions have looked into offering reverse mortgages, or similar, to meet your needs.

With a typical reverse mortgage, you get regular monthly payments. And when you sell your house, or die, the financial institution owns part or all of the house.

So far, though, only a couple of firms - Invincible Life Assurance (136 The Terrace, Wellington) and TSB Bank (PO Box 240, New Plymouth) - offer that sort of thing.

Give them a try. Their products don't suit everyone, however. So let's look at your selling and renting idea.

First, the worries:

Interest rates may fall, as you say. Long-range forecasts tend to be for lower rates.

You say "rent and our luxuries may increase." Make that "will increase." Even with inflation low, prices rise a fair bit over 10 or 20 years.

I assume you've checked that you can rent a nice place in your region for $7000 a year. Can you also get a long-term lease? You don't want to be forced to move every few years.

I'm also worried that you will eventually run out of money.

I agree with your calculation that you would have $134,000 after 10 years. But because your capital is diminishing, it brings in less interest each year. That, in turn, means a bigger bite out of the capital the following year, which leads to less interest again.

If you continue the calculations, you'll be right out of money in about year 20.

That might seem okay. You'll be in your mid-80s by then and may be happy to settle for fewer luxuries.

But what if interest rates fall and rents and other costs rise? Your money might last much less than 20 years.

And what if you take on too much risk, in pursuit of a higher return, and lose your capital? It's time for buses, camping and free TV.

But let's not be too gloomy. After all, the only essential spending in your plan is the rent. Invest conservatively to make sure that's always covered.

Beyond that, if things don't go as well as you hope, you could always take cheaper holidays or run just one car, or, okay, you can keep the beers, but only if your wife also gets regular treats!

Don't forget, too, that you'll free some cash by not paying house insurance and rates. And consider putting your $40,000 of other investments into the pool. That would make quite a difference.

If you want to be sure to have a regular income until you die, or for a fixed period, you could buy an annuity with your $200,000 or $240,000. An insurance broker will get you some quotes.

But an annuity probably wouldn't bring in as much income, and wouldn't give you as much flexibility.

Either way, with an annuity or following your plan, I reckon it could work.

Many retired New Zealanders wouldn't contemplate losing the security of home ownership and taking on the risks of falling interest rates and rising costs.

But if you can both cope with that, you'll probably end up having more fun. May you luxuriate - and read the Herald - for many years yet.

Q. My wife and I are both 47 and, if all goes to plan, we should have paid off our mortgage by next year. Our combined annual income is about $110,000, and we have two teenage children.

The question is, what next? I'm far from sure about what to invest in, although we do have a few opinions that may or may not be valid.

We are not at all impressed with the NZ Stock Exchange and would like to invest a large proportion offshore. There seems to be an absence of quality stock on our local market, and our faith is undermined by insider trading.

What is the smartest way to invest overseas from New Zealand and what are the tax implications?

Having bought a house, we don't want to get involved in more property.

We have been in a variety of managed funds and policies in the past, and our impression is that they often cost more to manage than they return.

In the end, the fund managers seem to invest in the same markets as we could ourselves, so what's the point?

A. Don't write off New Zealand shares too quickly.

Lots of people have been bashing Kiwi companies. And it may be justified. But - and this is important - the prices of those shares reflect the low regard for them.

By world standards, New Zealand shares are cheap. So they may be just as good a buy as overseas shares, perhaps even better.

And there's more. As Edward Smith, of Frank Russell Co, points out in recent article, the prices of our shares are largely set by big overseas institutions, which can't take advantage of dividend imputation.

For New Zealanders, who can, imputation is like a bonus that hasn't been allowed for in the pricing.

In light of all this, you might want to invest a portion of your savings in the local market.

Still, going overseas with the bulk of your money is a good idea. So how to do it?

You're quite right about many managed funds. The fees are pretty high and, in a bad year, can outweigh the returns.

Don't forget when you're looking at returns to include not just distributions but gains in the unit price.

However, you're not so right when you say you could make the same investments as fund managers do.

Because they have so much more money to play with than you do, they can go into many more shares and pay much lower brokerage per share.

Another advantage is that the managers handle all the different dividends, share buybacks, share splits, takeovers and other goings-on. You need to keep track of just one investment, which in turn keeps track of, perhaps, hundreds of other investments.

Most fund managers also have people and tools to research the markets. But that doesn't matter as much to me as to others. I'm not convinced that, even with those resources, they pick good shares over bad shares often enough to justify the expense of the research.

That's one reason I like index funds, which simply invest in the shares in a sharemarket index. The managers don't pick shares, which makes the funds cheaper to run, so the fees are lower.

And, over the long term, index funds tend to perform better than most other funds - sometimes called active funds - especially after taking fees into account.

In New Zealand, too, there's a tax advantage. Index funds don't pay tax on capital gains made within the fund; active funds do.

That makes quite a big difference to returns.

When you add all of this up, I think you're clearly better off in a New Zealand-based international index fund than trying to invest overseas on your own.

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