For years now one of the most sensible, reliable and accessible commentators on investing in NZ has been Mary Holm. She runs seminars, advises government agencies and working groups, writes a great column for the NZ Herald and is generally just New Zealand’s favourite financially savvy auntie.
New Zealanders are not always the best with financial literacy. We are often more scared than we should be of the sharemarket, we are famously not scared enough of piling ridiculous share of our wealth into investment property. We naively invested huge sums into dodgy finance companies and then the government had to bail us out to the tune of more than $1Bn! We don’t tend to teach financial literacy at schools, except a few courses run mostly by banks, and many of us learned only the basics (or perhaps just bad habits) from our parents.
Thankfully the Reserve Bank is here to save the day. As part of their focus on financial education they commissioned Mary Holm to write a simple booklet to make the complicated topics of saving, investing, and risk simple for everyday New Zealanders. It’s my favourite kind of book, it’s only 60 pages long, has small pages and has lots of pictures, tables and graphs to explain stuff.
Its available FREE to everybody on the interwebz right here on the RBNZ site:
Or, if you prefer the crisp feel of a page beneath your fingers. I have limited edition paper copy of the book that I can send out to one lucky winner. Just comment below with your saving and investing questions and I’ll randomly select one lucky winner to send the booklet to.
However, there are three investment options are objectively better than ETF and Index fund with low entry requirement, low risk and high (sometimes guarantee) return. They are the low hanging fruit of personal finance that everyone should do it. Those three investments options are pay off consumer debt, join KiwiSaver and reduce the mortgage. I will go through each one of them and talk about they risk and return.
No.1 Pay off Consumer Debt
Credit card debt, car loan, payday loan, personal loan, hire purchase, P2P loan… All of those are consumer debt. Debts that are owed as a result of purchasing goods or services that are consumable and do not appreciate in value. Those debts usually have high-interest rate and exorbitant admin fee. If you are paying interest on depreciating assets, they are dragging back you financially. You won’t go forward if most of your income goes to those stupid bills. You need to get rid of them ASAP!
Paying off debt is Investing
This concept may not be obvious to everyone but PAYING OFF DEBT IS INVESTING. For me, debt and investing are just two sides of the same coin. One side (investing) is to increase your wealth (with a given level of risk). Like you buy NZ Top 50 ETF from SmartShares, if the share price increase and they pay out a dividend, your wealth increased. On the other hand, the shares price may drop, and your wealth will decrease. So there is a risk of losing money with investing.
The other side of the coin (debt) will reduce your wealth. If you have $1000 credit card debt with 20% interest, your interest expense for the first month will $16.67. So your wealth reduced by -$16.67. Unlike investing, the debt will guarantee to reduce your wealth and drag you back financially. Therefore, reduce your debt will move you forward financially, guaranteed.
Whats the return and risk?
I will use a simplified sample to present the financial effect of paying off debt.
Assume you have $1000 in cash and $1000 credit card debt with 20% interest. If you keep the $1000 in cash and don’t pay it off credit card debt, in one year, you will be $1000 x (1 + 20%) = $1200 in debt. Financially you moved backwards by $200.
Now, you invest the $1000 cash in a 12 months term deposit with 3.25%. You still keep your $1000 credit card debt and not paying that off. In one year, your earn $1000 x 3.25% = $32.5 in interest from your term deposit. Take away $9.75 as tax; you will have $1022.75 in cash. On the other hand, your credit card debt still cost you $200 in interest. So financially, you moved backwards by $177.25.
Instead of invest that $1000 into a term deposit, you use that $1000 to pay off your credit card debt. Since the credit card debt is gone, it won’t occur interest. In one year, you will be in the same financial position.
Look at all three scenarios, pay off credit card debt resulted in the best financial position. As you putting that $1000 cash to pay off your credit card debt, you are in fact getting 20% return on those $1000. Unlike other investment, those returns are Tax-free and guaranteed. If you need to get 20% after-tax return on investment, the pre-tax return will need to be 27.77%. That is an excellent return on investment. I am not saying you can’t get 27.77% return out there, but I am sure there is no investment (except KiwiSaver) can guarantee a 27.77% with no risk.
If we look that those high-interest-rate consumer debts, paying them off will be a great return for your money. Also, paying off consumer debt will reduce your financial risk and stress. You will be in a much better position when you negotiated mortgage term and resulted in better deals. That why paying off consumer debt is one of the top three investment options.
What about Student Loan?
The student loan in New Zealand is interest-free as long as you are staying in the country. The payment only occurs when you have income. So you should just pay it off as you’ve got income. I would not be paying them off early unless you plan to leave the country for a long time.
No. 2 – Join KiwiSaver
KiwiSaver is a voluntary, work-based savings initiative to help you with your long-term saving for retirement. It’s designed to be hassle-free, so it’s easy to maintain a regular savings pattern. Once you join KiwiSaver, at least 3% of your income will invest into a KiwiSaver fund. You can only access those fund until you use it to buy your first home or turn 65. What makes KiwiSaver to be a top investment option is because of employer contribution and member tax credit.
If you’re over 18 and is a member of KiwiSaver, when you make your KiwiSaver contribution, your employer also has to put money in. By law, the employer required to contribute at least 3% of your income. The employee can choose to contribute either 3%, 4% or 8% but employer only requires to match at 3%. Some employer may decide to match 4% or 8%.
It may seem you will be making 100% return on investment on your 3% contribution. However, IRD will take out tax from you employer contribution, so the actual return on your contribution is about 67%-89.5%. (You can find out why here) It’s still an unbeatable risk-free guaranteed return.
Member Tax Credit
KiwiSaver Member Tax Credit is to help you save on your KiwiSaver. The government will make an annual contribution to your KiwiSaver fund (a.k.a Free money). The amount is $0.5 on every dollar up to $521.43. You will have to be 18 or above to receive the tax credit. This is a way of government help you save for your retirement and encourage you to join the plan. It cap at $521.43 so it will benefit for the most full-time employee but not favour mid to high-income earner.
Return on Employee
If you are over 18, fully employed, annual income at $55,000 before and contribute at 3%. Your minimum return on your contribution will be like this.
Your annual contribution (3%): $1650
Employer contribution after tax: $1361.25
KiwiSaver Member Tax Credit: $521.43
The return on your investment: (1650 + 1361.25 + 521.43 – 1650) / 1650 = 114%
Return on Self-Employed
If you are self-employed, you won’t get the employer match, but you are still entitled to member tax credit as long as you make a minimum manual contribution for $1042.86
Your manual contribution: $1042.86
KiwiSaver Member Tax Credit: $521.43
The return on your investment: (1042.86+ 521.43 – 1042.86)/ 1042.86 = 50%
Those are only your base return; you are likely to make investment return on your KiwiSaver Fund as well. Here is a couples data on a KiwiSaver fund with different income level. The KiwiSaver fund cost and return data are based on SuperLife 80.
No. 3 – Reduce your Mortgage
Mortgage payment can easily be the biggest expenses on most homeowners’ budget. Average first home buyer will spend $1500/month on the mortgage, and it will cost more if you have a mortgage in a major city. Imagine what you can do with that money if you don’t have a mortgage payment.
Return on Reducing Mortgage
Paying off have the same effect on paying off consumer debt. It will give you a tax-free and guaranteed return. The return is not as high as those consumer debts because the interest rate on the mortgage is lower at 4% – 6%. The equivalent pre-tax return is around 8.3%.
Reduce your Mortgage or Invest elsewhere
Some people may think 7-8% is not a very good return, and you can achieve that with other investment options without taking a lot of risks, like the share market. However, I still think paying off the mortgage on your own home is a better option because you are paying off an asset that will provide you with a place to live, offset the cost of renting in the future and the house will increase in value (in the long term for most cases).
If you can’t decide to reduce mortgage or invest elsewhere, ask yourself a simple question:
If you fully owned your house today, will you borrow $500k on your mortgage-free house to invest in share market? Or you will use your income to invest in the stock market every month?
If you say you won’t borrow on your mortgage-free home (like me), then you should focus on reducing that mortgage now. I basically asked the same questions but put it in a different perspective. If you have the money to reduce the mortgage, but you put it into the share market, you are basically borrowing on your house to share market.
Saving Big on interest expense
Since the mortgage size is usually over $200K (over $500k in Auckland) and the payment terms are 20-30 years. You end up paying A LOT on interest expenses. Check out the chart below.
For a 30 years term mortgage at 5% interest rate, you will end up paying 93% extra for interest payment. So what will happen if we increase our payment and shorten the mortgage by ten years?
When we shorten the mortgage term by ten years (-33%), our monthly payment increased by 23%, total interest paid decreased by 37.3%! Only 36.9% of your payment went to interest.
Reducing mortgage may not give you a high percentage return, but due to the size of the mortgage, the saving you are likely to make is in the hundreds of thousands. I will have a series of blog posts in the coming month to show you how to be smart on your mortgage with different setup and tips.
The top 3 investment options in New Zealand are paying off consumer debt, join KiwiSaver and reducing your mortgage.
Paying off consumer debt is investing. The returns are in the range of 15% – 35%. You will be in a better financial position once you pay off your debt.
A KiwiSaver member can enjoy instant return from minimum 50% – 110% due to member tax credit and employer match. However, that money is locked-in until you purchase your first home or turn 65.
Paying off return about 7% – 8% on your dollar, not as high compared to other. However, due to the size of the mortgage and interest paid, you are likely to be saving hundreds of thousand of the dollar
By New Zealand law, employers are required to contribute to their employee’s KiwiSaver account or complying fund at 3% of their gross salary or wage if the employee has joined Kiwisaver. However, when you look into your KiwiSaver contribution transaction record as an employee, you may notice the employer contribution amounts are less than your employee contribution.
Here is an example, assume your weekly income before tax is $1200, $62400/year.
Without KiwiSaver, your take home pay will be $1200 – 225.77 (PAYE) – 16.68 (ACC) = $957.55.
If you join KiwiSaver and contribute 3%, your take home pay will be $1200 – 225.77 (PAYE) – 16.68 (ACC) – 36 (KiwiSaver) = 921.55. On your KiwiSaver statement, your contribution will be $36, however, your employer contribution will be $25.2, not $36. Why?
The reason is that employer contributions are taxed under Employer Superannuation Contribution Tax (ESCT). Your employer pays out an extra 3% of your income to KiwiSaver but part of that went to IRD as tax.
You may think ‘If both employer and employee are paying 3%, how come the cash hit my KiwiSaver fund is different?’ (That was me two days ago)
Let’s break it down in detail. The 3% contribution is calculated based on your income before tax. In our example, the weekly 3% KiwiSaver contribution will be $1200 x 3% = $36. So both employee and employer will pay $36 each into the KiwiSaver Fund.
Here is the tricky part, on the employee contribution, it was calculated based on pre-tax income and taken out of after-tax income. So the $36 will be taken out after they deduct PAYE and ACC and that $36 will reach your KiwiSaver fund without IRD taking out any more tax.
On the other hand, employer contributions will be taxed under ESCT. So 30% of $36 = $10.80 will go to IRD, and the cash that hits your KiwiSaver fund will be 36 – 10.8 = $25.2
Therefore, I was wrong by saying you will have 100% return on your employee contribution. It’s more like 67%-89.5% return. It’s still an unbeatable risk-free guaranteed return and one of the best investment in New Zealand.
So i guess one of the first and easiest places to start investing is in kiwi Saver.
What is Kiwi Saver?
Kiwi Saver is a voluntary, work-based savings initiative to help you with your long-term saving for retirement. It’s designed to be hassle-free so it’s easy to maintain a regular savings pattern.
If you choose to join, contributions are deducted from your pay at the rate of either 3%, 4% or 8% (you choose the rate) and invested for you in a Kiwi Saver scheme.
– The key win here is that your Employer also contributes a percentage
(Normally 3%) Already you have 100% profit gain just by being involved!!!!! where else can you get that kind of return?!!
but wait there’s more…..
Member tax credit
To help you save, the Government will make an annual contribution towards your Kiwi Saver account as long as you are a contributing member aged 18 or over.
Government will pay 50 cents for every dollar of member contribution annually up to a maximum payment of $521.43. This means that you must contribute $1,042.86 annually to qualify for the maximum payment of $521.43.
(This is a repost from thesmartandlazy.com, published on May 17, 2017. This post contains the concept of Financial Independence & Retire Early (FIRE), and terms like 4% withdrawal rate that may sound confusing. If you like to know more, jump to the end of this blog post for more information.)
When we approaching June in New Zealand, you can see lots of personal finance articles tell everyone to put in some money into their KiwiSaver and get the free money. I want to focus on a group of people who is working toward financial independence and wants to retire early. They may think since they are planning to retire way ahead of 65, KiwiSaver is irrelevant to them. They could be in KiwiSaver, but not sure if they should include KiwiSaver as part of their financial independence plan.
Return on your KiwiSaver contribution
If you wish to live off your saving and investment, you ought to find the best return on investment out there. For KiwiSaver, your employer has to match your 3% contribution, and some employer may go higher. That’s 100% return on investment! (Correction: Actually is not 100% return because the employer needs to pay tax on their contribution. So the ROI is 100% – Tax, from 10.5%-33% less. Still a great return)
The government also provide KiwiSaver member tax credit for the first $1042.86 contribution from you each year (not counting your employer contribution). The Government will pay 50 cents for every dollar of member contribution annually up to a maximum payment of $521.43. That’s 50% return on your first $1042.
If your wife/husband/partner is not working and you are working full time, you should consider contributing $1042 into their account as well. Those credits are risk-free and guaranteed. It is hard to find such return on the market with basically no-risk.
Locked until 65
Some people think the big problem of KiwiSaver is you cannot access the fund until you turn 65 or to buy your first home. For the people who are planning an early retirement, they like to put every dollar into their investment so the investment can generate enough income to support their living expenses. They don’t count on KiwiSaver and NZ superannuation to retire. However, you should still put money into your KiwiSaver.
One simple question: Do you plan to live beyond 65? If yes, then you should contribute to your KiwiSaver because it’s your money! You will spend on your investment before 65, and you will still spend on your investment after 65. The KiwiSaver fund is just one of your investment funds, and you don’t draw on that fund before 65, it will still help you to achieve your financial independence.
Include KiwiSaver fund into your early retirement number
Look at the graph below. We assume you need 1 million portfolios to retire early, $300k in KiwiSaver and $700k in a normal investment fund. Your annual withdrawal rate 4%.
You just need to stack up your investment and put KiwiSaver at the bottom and only draw the fund at the top. You keep drawing your non-KiwiSaver investment fund before you turn 65 and let your KiwiSaver Fund untouched. Yes, your non-Kiwisaver fund may get smaller and smaller (depends on your withdrawal rate) because you are drawing $40K (4% of 1 million) on a 700k investment fund. However, your KiwiSaver fund will keep growing. When you reach 65, you can draw from both funds.
Therefore, you should keep contributing to your KiwiSaver and include KiwiSaver as part of your early retirement plan.
Don’t over contribute into KiwiSaver
The key is you should not put too much into your KiwiSaver. You don’t want your non-KiwiSaver fund run out of money before you reach 65. Although it’s unlikely but possible.
Let’s assume you are 40 years old and have 1 million investment portfolio. You plan to draw 4% on your investment every year for living expenses. The expected return on investment is 6%. However, for some unknown reason, 70% of your investment are in KiwiSaver, and only 30% of your investment are in non-KiwiSaver Fund. You can only draw from your non-KiwiSaver fund before you turn 65.
By age 48, your total portfolio growth to 1.24 million but your non-KiwiSaver fund ran out. Most of your money are locked in KiwiSaver, and you are 17 years away to access them. You need to go back to work.
To avoid that, you just simply contribute up to wherever your employer will match and enough to get the member tax credit every year. Put all extra cash into your non-KiwiSaver investment, including paying off mortgage, shares, bond, property, etc.
Now, if we reverse that situation and put 30% investment in KiwiSaver, 70% in non-KiwiSaver. That non-KiwiSaver fund will least 30 years. Here is the how the fund works.
How long will you non-KiwiSaver fund least?
I actually worked out the formula on how many years your non-KiwiSaver fund will least base on percentage of your portfolio in KiwiSaver. The graph was based on 4% withdraw rate.
X is the percentage of your KiwiSaver and Y is the number of years will your non-KiwiSaver fund last.
If your Kiwisaver is about 18% of your total investment and you are 28, do you need to worry? Using that formula y = -24.61(0.18) + 0.3429, y =42.5. Your Non-Kiwisaver fund will least 42.5 years, by the time your non-KiwiSaver fund runs out, you are already 70 years old.
If you plan to retire at age 38, you will have to draw on your non-KiwiSaver fund for 27 years. Using that formula 27 = -24.61 In(x) + 0.3429, x = 33.85%. So your KiwiSaver needs to be less than 33.85% of your total investment portfolio.
That formula only works with 4% withdraw rate. You can work out how long will your non-KiwiSaver fund least with your own figure. Check out this google sheets. Make a copy and play around.
KiwiSaver is a great investment with a high return on investment due to employer match and government tax credit. It is one of the best investment in New Zealand.
You should contribute toward your KiwiSaver to achieve Finacial independence and include your KiwiSaver amount into your equation.
Do not over contribute into your KiwiSaver.
If you are employed, you should contribute up to your employer match and no more.
If you are self- employed, just put in $1042.86 to get your $521.43 tax credit every year.
All extra cash goes into non-KiwiSaver investment.
If you are not retiring extremely early (in your 20s) and your KiwiSaver is below 20% of your total investment portfolio, you will be alright.
If you want to know more about Financial Independence & Retire Early, I will cover that in the future. Meanwhile, Check out the link below.