Two readers commented on my June 16 column on KiwiSaver.
Grant Bulley writes:
KiwiSaver contributions are only a relatively small component of the overall capital value of your KiwiSaver account; that is, what is happening to the funds you put your hard earned money in? To the end of May, the Fisher Funds “balanced strategy fund” had only returned 5.8% before tax since 2009. In other words, any capital you had after tax and infl ation erosion of about 8% in three years leaves you in firm negative territory, with your KiwiSaver sum worth less now than three years ago. Compare this with putting money into reducing a mortgage costing, say, 7% compounding over the past three years, and you have to wonder why we have KiwiSaver? I challenge you to do a follow-up looking at the bigger picture from an investor point of view.
Meanwhile, Philip Strang says:
The central thesis of that article was it is better to make KiwiSaver contributions than to repay mortgage debt. I crunched the numbers and found the writer was correct – for the scenario outlined. Modelling different scenarios, the picture became somewhat different as the level of income grew and once income returns were added. Repayment of a mortgage returns a yield of whatever the prevailing interest rates are; say 5-6%. Returns on KiwiSaver funds are variable according to the risk profi le of the chosen fund and the fortunes of the market, but are of course subject to fees and tax. It may be reasonable to project an investment return after fees and tax of 2-3%, but no more, and quite possibly less. It would be interesting to see an article written for the more typical person wrestling with the save or repay debt dilemma. In general it appears debt repayment becomes the more attractive option as income grows, the gap between the two respective investment returns widens, and state inducements reduce proportionately over time. If tax were removed from savings and added to the incurring of debt then not only would this model change but the overall economy would be far better positioned. Oh, the benefit of hindsight.
First, the Fisher Funds return Grant quotes is annual, not over three years – so nearly 6% a year is not too bad, although investment returns generally have not been particularly good over recent years, given depressed markets. But Grant and Philip miss the key point of my column: individual KiwiSaver contributions are subsidised, first by the employer and then by the Government. Yes, the benefits are highest for those on lower incomes, but getting the benefit of an employer’s contribution will mostly outstrip returns a fund manager can generate, even with larger amounts. KiwiSaver has been designed around the average wage; you get the most benefit if you contribute around $1000 a year, your employer does likewise and you receive the Government’s maximum $520 tax credit. Obviously this becomes less significant the larger your contributions.
On the flip side, with 50-year low mortgage rates, it’s a great time to borrow money. As a general rule, reducing debt gives you the best return you can make. For example, in approximate terms, if you have a $500,000 mortgage to pay off over 30 years at 6%, you will end up paying more than the borrowed amount in interest alone. If you pay it off over 20 years, the interest drops to less than $360,000, and over 10 years it is “only” $165,000. So you have to make some pretty good returns to beat the financial benefit of reducing debt. The more you repay, the more stays in your pocket rather than going into the bank’s. The trouble is most Kiwis end up owning their dream home, but with no other income to live on. So KiwiSaver teaches the discipline of putting money aside – and having eggs in more than one basket.