Investing while you are borrowing

WITH MARY HOLM

Q: I am in my mid-50s, single and enrolled in the Government superannuation scheme - rather late in the day.

I am thinking that I could retire from the present job at about age 62, take the superannuation and get a less demanding job to live on, while saving the super to put into the investments I have. They are in managed funds. I would value your comments.

How do I replace my ageing car? It would cost up to $15,000 for a lower mileage second-hand car. Do I withdraw from the fund that is not performing and then pay back into that fund? Or do I get a loan, maybe extend the one on the house and pay interest? I am currently saving $400 a month, to increase my investments, which are compounding.

A: Your plan for gradual retirement, by taking a less demanding job, sounds good to me - particularly as you expect to continue to save.

Your more immediate question, about how to finance a car, is a bit trickier. Ideally, you and everybody else should plan for big purchases such as cars.

Let's say you expect to spend $15,000 - after subtracting whatever you hope to get for the old car - every five years.

You should set aside $3000 a year, perhaps in term deposits, for the purpose.

In practice, though, too few people think like that. So here you are now, needing a lump sum.

Let's say, for the moment, that you decide to borrow for the car. You're right that the loan should be an addition to your mortgage. The lender has your house for security, so the interest rate will be lower than on any other loan.

Once you've got the loan, you're faced with the question of whether you should put your savings into repaying it quickly or into your investments.

Given your age - and I also sense that you're not a great risk-taker - you would probably want to repay the mortgage fast.

You would be increasing your wealth as much as if you had an investment earning a return that equals the mortgage interest rate. These days, that's pretty good.

There's a catch here, though. The "return" on repaying your mortgage is high only because mortgage interest rates are quite high by recent standards.

In light of that, is it wise to extend your mortgage to start with? Would it be better to just take the car money out of your savings?

For that matter, should you have been investing anyway, before the car came up? You've obviously already got a mortgage. Perhaps all your savings should go into getting rid of it as soon as possible.

The crux of the matter is this: You would be better borrowing for the car, and retaining your current mortgage, only if the return on your savings is higher than the mortgage interest.

Lately, the returns on many managed funds have been negative. This won't continue. They will zoom up again, but we don't know when. It's all a bit risky.

In your circumstances, you'd be better to take the car money out of your savings.

Don't, though, empty out the fund that isn't doing well. That means you will have bought high and sold low. Ugh!

If anything, funds that have done badly tend to do better in the following year than those that have done well. So I would take an equal amount out of each fund, or perhaps more out of the ones that have performed well.

Beyond that, logic would suggest that you should also liquidate your savings to reduce your current mortgage.

But I think that would be going too far.

Now that you've got the investments set up, taking money out and then later putting it back in costs entry and exit fees or brokerage or similar.

A good compromise would be to put all your future savings into getting rid of your mortgage. It's great to approach retirement with a mortgage-free house.

Then, get back into those share funds.



* Mary Holm is a freelance journalist and author of Investing Made Simple. Send questions to Money Matters, Business Herald, PO Box 32, Auckland; or email: maryh@pl.net.

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