Mary Holm: Whats first – get into a home, or out of a debt?

OPINION:

Q: What should my millennial daughter concentrate on in terms of her financial future? She is 25, and has just started her first job as a medical professional after seven years of study. She has a student debt of just over $100,000.

She has a KiwiSaver which her parents set up for her, and this has around $20,000 in it. Should she pay off the debt, save for a house or contribute to the KiwiSaver?

A: There are three ways to look at this:

• Ethically, she should repay her student loan as fast as possible. She borrowed taxpayer money — including from people on the minimum wage — and it could be used for other good purposes.

• Psychologically, she may want to get rid of such a large debt quickly.

• Financially, she should pay off just the compulsory amount from her student loan — 12 per cent of every dollar she earns above $20,280 a year. The rest of her savings should go into KiwiSaver, from which she can withdraw everything except $1000 if she wants to buy a first home.

When you repay a debt, it improves your wealth in the same way as an investment earning whatever the interest rate is on your debt. For example, if you are paying 20 per cent on credit card debt — ouch! — repaying it is like making a risk-free investment with a 20 per cent return. Fantastic.

But repaying a student loan — which is interest-free as long as you live in New Zealand — is like making an investment with a zero return. It’s pretty easy to beat that in KiwiSaver.

$1.5m and a benefit

Q: Thanks for putting that woman in her place last week, regarding her plan to stay on the benefit while collecting her $1.5 million inheritance. Her plan just pissed me off no end, and I hope she sees either the error of her ways or a visit from the MSD investigator.

A: A question for you: when you read the Q&A above, did you think it’s okay for the young woman to pay off her student loan as slowly as possible while saving elsewhere?

She will probably make pretty good money from now on, and could repay the loan fairly quickly. But many people will approve of her investing instead.

I’m not saying this is the same as a beneficiary not declaring an inheritance to MSD. For one thing, the student loan situation is legal. But there are similarities. Both women would be keeping taxpayer money they don’t need. Food for thought?

Last week, I didn’t see myself as putting the reader in her place. I was just telling her the rules. I had a bit of correspondence with her actually, and she didn’t come across as greedy, just unsure of her position.

Compassion is good.

Surviving on $16,432

Q: I’m writing about the millionaire beneficiary last week. My God. Supported living is actually $316 a week now. That’s $16,432 a year.

Work that out, into $1.5m. She could live as she is now for longer than the rest of her life, and she wants to keep getting the benefit?! Even if she doubled it, she could still live forever on that. Greed.

A: I take your point. But can I just ask if you would be happy living on $16,432, or double that, a year?

By the way, the support living payment varies with people’s circumstances.

Sub-par?

Q: I have to take issue with the headline on your latest column, probably not your fault — maybe just another example of the poor sub-editing in NZH: “The millionaire single woman earning a benefit”.

As you rightly state in your reply to this person, the MSD work on the principle that “assistance is provided based on need” — it is granted by way of a “benefit”. Definitely not what I would call “earned”!

A: It probably wasn’t the best word choice. But an argument can be made that contributing New Zealanders who then strike major health problems — as last week’s correspondent did — have earned the right to support from the state.

On sub-editing, I have worked for nine newspapers, big and small, in three countries. My friends have always complained about subbing in my paper. But as a wise person once pointed out, what other industry produces a whole new product every day? Expecting perfection is unrealistic.

Outrage misplaced

Q: I’m anticipating justified howls of outrage about your millionaire on a benefit, and would like to present a different story.

I am a single woman on a supported living benefit of $400 per week. With the energy supplement it’s $21,280 per year. Many people with illness and disability are on a similar income, often with no way to earn on top of this, and live in material hardship — receiving less than 60 per cent of the median wage of $56,000.

I received an inheritance of $140,000 in 2007.

I showed Winz the costings I had prepared to: pay off my house; buy a modest new car (my old one had over 400,000 km on the clock!); and do much-needed property maintenance. They were supportive.

I invested the residual funds in term deposits. The interest was declared annually and treated as income.

I was able to resume doing volunteer work, pay for appliances and car repairs and travel to see whānau and access medical treatment. I have an emergency fund.

I don’t know anyone on supported living who wouldn’t happily and immediately exit the welfare system if they got a windfall of $1.5m. They could stop living in caravans and garages.

A: It’s good to know you could use some of your inheritance to set yourself up better, while keeping the benefit. I’m glad Winz is flexible about this.

Clearly your inheritance made a big difference to your life — and not just yours, given that you now do volunteer work.

Borrowing to invest

Q: I refer to your recent Q&As about borrowing to invest.

It is important to point out that when you buy shares, you are already buying a leveraged investment. Many companies on the sharemarket have debt that needs to be paid back before the shareholder is paid out.

On the other hand, when we buy a property directly, we borrow, but there is no other debt.

I don’t think borrowing to buy shares is bad, but people need to understand that they are increasing the leverage of an already leveraged investment.

A: You’re right that many companies have debt. And if they go belly-up, the lenders are paid back before shareholders get any money. But usually companies borrow not because they are in financial trouble, but because they want to grow their business.

Still, I agree with you. The fact that companies hold debt is one reason that shares tend to be higher-risk investments than property. If you add borrowing when investing in either, shares will probably stay riskier than property.

Note, though, that it’s much easier to diversify shares than property. And that reduces risk.

KiwiSaver fees

Q: In the Q&A about KiwiSaver fees last week, the reader said, “Of my personal contribution of $640 per month, approximately $420 is taken away as fees, leaving a net contribution of $220”. I’m sorry, but that does not even begin to sound rational. If there was/is any KiwiSaver provider that actually behaved that way, they need to be named and shamed and probably a whole lot more.

But more than that — as a director of Financial Services Complaints Ltd, and an ex-director of the FMA, you will appreciate how published assertions like this can be used by people as (apparently powerful) examples of why not to invest in KiwiSaver. I think it is particularly important that the facts of this case be established and reported on.

A: The numbers are correct. The provider wouldn’t deduct their fees from the reader’s contributions on their way into his account. But it would take the money out of the account each month, which amounts to the same thing.

The situation arises because KiwiSaver fees — apart from admin charges — are percentages of each member’s balance. When the balance rises, so does the fee. As our reader pointed out, in a few years his fees could be higher than his contributions. His account will still grow from returns, but it’s not good.

While I recommend KiwiSaver to everyone, I don’t defend everything about it. My job is to help readers make the most of the scheme, and to point out its flaws.

KiwiSaver fees #2

Q: The KiwiSaver fees quoted in your column were about 1 per cent of the reader’s $508,000. Don’t most KiwiSaver providers charge at higher rates than this?

Over less than 15 years (since July 2007) the correspondent’s total personal contributions appear likely to have been less than $100,000 (14.5 years times $640 a month — the current contribution — equates to about $110,000).

Therefore, it appears your correspondent has been served well by the scheme — something like a five-fold return thanks to their provider, and government and employer contributions. Perhaps the provider’s fees are not so outrageous after all?

A: There is much we don’t know. The reader might have contributed at a higher rate earlier on, or added, say, an inheritance.

If not, then yes, the government and employer contributions and provider’s returns have given the reader healthy growth — as we would expect in an unusually long period of strong sharemarket performance.

But fees can make a big difference to KiwiSaver growth. So is 1 per cent high?

It seems the reader is in a growth or aggressive fund. The range of fees for those funds, according to the Smart Investor tool on sorted.org.nz, are:

• Growth funds: 0.47 to a ridiculous 3.07 per cent. The average is 1.48 per cent. Six providers offer funds with fees below 1 per cent.

• Aggressive funds: 0.31 to an even more ridiculous 4.37 per cent. The average is 1.23 per cent. Three providers offer several funds with fees below 1 per cent.

So you’re right, 1 per cent is not high comparatively speaking. But when it amounts to $420 a month, it’s still too high. In a later email, the reader said, “I look at the fee alongside all of my other monthly expenses — and it’s the highest of them all — even more than my rates and electricity bills.” I think it would be fair if percentage fees were reduced on higher balances.

But — importantly — this should not be at the expense of those with lower balances. As the Financial Markets Authority and others have pointed out, there’s room for KiwiSaver providers to reduce their fees for everyone.

Cutting costs

Q: Your article last week prompted me to change my KiwiSaver to take advantage of the lower fees.

I went to SuperLife expecting to see a 0.2 per cent fee as you mentioned, but their fees are still circa 0.58 per cent plus an annual fee. Maybe you meant that the new fees come into effect on 1 December?

A: Good on you for planning to lower your KiwiSaver fees — a smart move.

But you’re right, the switch to the new default funds took effect on Wednesday. And on that day, the new SuperLife fund, with its 0.2 per cent fee and no admin fee, was listed on the provider’s website. Anyone who wants to be in a balanced fund can switch to that fund.

The provider does still charge admin fees of $30 a year on its other funds.

– Mary Holm, ONZM, is a freelance journalist, a seminar presenter and a bestselling author on personal finance. She is a director of Financial Services Complaints Ltd (FSCL) and a former director of the Financial Markets Authority. Her opinions do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to [email protected] Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.

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