Money matters: Two views on taking a risk

Q: I own a home worth about $320,000 and have a mortgage of about $100,000. I have no other debt and am in my mid-thirties.

I have read many books on money management, but they seem to offer conflicting advice.

Some say pay off debt first, others say pay off debt and start a savings programme simultaneously, for instance 10 per cent of income against debt, 10 per cent into an automatic investment programme.

At the moment I pay a bit over 20 per cent of my income against my mortgage.

Would I better to start a savings programme?

P. S. Most years I earn more than $60,000. This year I expect to earn about $85,000. I do contract work, so my income is "at risk," and could fall to as little as $25,000 a year.


A: Ever noticed that whenever someone responds to a question with "That's a good question," they don't have an easy answer? Well, yours is a good question.

There are probably two reasons for the conflicting advice you've read.

One is that different people have different attitudes to risk. The other is that some money management experts are more inclined than others to take into account non-financial factors.

We'll look at risk first.

Let's say that you pay $1000 more off your 8 per cent mortgage than you have to. That means that you avoid paying 8 per cent interest, or $80 a year, on that $1000.

To do better than that by investing the $1000, you would have to earn more than 8 per cent, after tax, on it.

Generally speaking, you can't do that with term deposits. Banks have to charge more for mortgages than they pay on deposits, or they would go broke.

It is possible to have a long-term deposit, set up before a big interest rate drop, that pays more than current mortgage rates. But that situation won't last long.

Usually, you have to go into risky investments, such as shares or property.

And because they are risky, you can't be sure where you stand.

A couple of years ago, after-tax returns on international shares were much higher than 8 per cent. But last year the returns were negative - the value of many world shares fell. If you go back a few more years, you get the same story on houses.

Looking ahead, the experts expect average returns on shares and property to be lower than over the last few decades - partly because inflation is lower. So if you go into an investment, rather than paying off your mortgage, you might be lucky to average more than 8 per cent after tax.

Of course the experts might be wrong. Maybe you'll get 15 or even 20 per cent for a while. Then you'd be laughing.

You are taking a risk, though, whereas paying off your mortgage is like a risk-free investment.

When you look at it from a purely financial viewpoint, then, only those who enjoy a bit of a gamble should invest while they've got a mortgage that can easily be paid off.

As I said, though, there's a non-financial view, too.

If you're paying off your mortgage but also regularly investing in a share fund, you're learning about long-term market trends.

Over the years, prices might soar, then plunge, then perhaps rise slowly. If you've hung in there through all of that, you'll feel more confident about investing much larger amounts when your mortgage is paid off.

You've also got the advantage of diversification. Not all your money is in your house. If shares do well and housing doesn't, you've had a piece of the action.

Taking all this into account, it's not a bad idea to invest a little into a share fund while still paying off your mortgage.

If you're Nervous Nellie, make it just $100 a month. If you're Gambling Gertrude, go for more. In your particular case, with your erratic income, perhaps you should commit to a small investment in bad years, and add more in good years.

The bulk of your savings, though, should still go into getting rid of that mortgage as fast as possible. It's an excellent "investment."

One last thought: If you can get into a superannuation scheme that is generously subsidised by your employer, you might have a good chance of earning more than your mortgage interest rate, after tax. Read on.

Q: With regard to the bloke (in Money Matters on February 10) who is in his employer's super scheme yet contributes $1700 a month to another registered scheme, do people actually understand the real value of employer subsidised superannuation?

If he has been with the employer for long enough to get a significant portion of the employer's superannuation dollars upon resignation from the company, then he may be better off to increase his own contributions to that scheme. This is particularly true if his entitlement to the employer's contribution is approaching 100 per cent.

Let's assume that he contributes 4 per cent of his salary to the work scheme, and the after-tax employer contribution is the same.

He is then attracting 100 per cent profit on his money each month, before the money is invested by the fund managers. And group schemes usually have much lower fees due to economies of scale.

If he decides to increase his personal contribution to 20 per cent of his salary, and the employer contribution is still set at the 4 per cent level, then for each dollar invested he gets an "instant return" of 20 per cent.

Let the bank or a private fund beat that.

Of course one always needs liquidity outside of such funds. But that's another story, and not one I'm qualified to address.

(Declaration of interest: I'm a trustee - for almost 14 years now - of a large company's superannuation scheme.)


A: Good point - although I've got a couple of quibbles.

First, you could be accused of putting things in too rosy a light. In your example, the company puts in a dollar for every dollar the man puts in, up to 4 per cent of his salary. How typical is this?

Of defined contribution schemes, which are the most common type of employer schemes, more than 90 per cent include employer subsidies to employees' savings, says David Stevens of the Association of Superannuation Funds of New Zealand. Some schemes also contribute to administrative costs.

In many cases, though, the subsidy is less than dollar for dollar. Even when it is that high, the employer's contribution is taxed at 33 per cent, so only 67c of that dollar makes it into the employee's account.

Still, some employers put in as much as $2 for every $1 from an employee - or $1.34 after tax. So we'll go along with your optimistic assumption.

As you point out, when employees leave a company, they typically get employer contributions only if they have been there for a certain period.

This is called vesting.

Sometimes, you have to be with the company for five or 10 years before you get any of the money they put in. Sometimes you get 10 per cent of its contributions after a year of employment, 20 per cent after two years, and so on.

If it's reasonably likely you'll be with your employer for a while, you're silly not to join a scheme and get at least some of the money they put in on your behalf.

In your example, the bloke has been with the company long enough to be fully vested.

His employer puts in $1 after tax for every $1 the man puts in. So, as you say, he gets an immediate 100 per cent return - brilliant - and then a further return of whatever the fund produces over the years.

You go on to say that if the man raised his contribution five-fold, he would get an immediate return of 20 per cent. And that's where my next quibble comes in.

Your maths is correct. But you're just watering down the subsidy. The man was already getting the maximum employer subsidy when he put in 4 per cent of his salary. He doesn't gain anything special from putting more money in.

He should choose the company scheme for his extra savings only if it's a good investment for other reasons.

One such reason could be the "salary sacrifice" tax break I wrote about on February 10, which benefits people who make more than $60,000 a year.

Another possible reason is that, as you say, group schemes often charge lower fees than individual savings schemes. What's more, employers sometimes pay those fees, and that can make a big difference.

In its brochure Saving at Work, the Office of the Retirement Commissioner gives an example of someone who puts $200 a month into a work scheme for 40 years.

Without the employer paying the fees, the employee's average return is 2.5 per cent a year. The savings total is $160,000.

But with the employer picking up the fees, the average return rises to 4 per cent a year. The savings total is a much higher $230,000.

The brochure has other information about employer super schemes. You can get it by ringing 0800 45 65 85, or via the internet at www.retirement.org.nz/reading/brochures/work.html.

Quibbles aside, your main point is good. While not every employer scheme is wonderful, they can be hard to beat if the employer pays the fees or subsidises your savings or both.

Q: If Lion Nathan gets 90 per cent of Montana before July 1, can they get the balance of 10 per cent of the shares in the company at any price they wish to give the remaining shareholders?


A: No. That would be extremely unfair. Whether the takeover rules are fair has been much debated lately. But they certainly don't treat shareholders that badly.

Once someone owns 90 per cent of a company's shares, compulsory acquisition takes place. In other words, the majority shareholder has to buy the rest of the shares - and the other shareholders have to sell.

But the majority shareholder doesn't set the price.

Under the listing rules and the constitution of the listed company, that's done by an "independent appropriately qualified person," says Philippe Leloir, secretary of the Stock Exchange's Market Surveillance Panel.

The panel has to approve the independent person, says Leloir. Typically it's a partner in a big accounting firm.

Even then, if shareholders with 10 per cent of the remaining shares are unhappy with the price that the independent person comes up with, they can get a second report.

The takeover rules, scheduled to take effect on July 1, aren't expected to significantly change how compulsory acquisition works.

* Mary Holm is a freelance journalist and author of Investing Made Simple. Send questions for her to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@journalist.com. Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number in case we need more information. Mary cannot answer all questions, correspond directly with readers, or give financial advice outside the column.