Q: I have several rental properties and was asked by a younger colleague how to get into the rental property "game" so they can get sorted for retirement.
I advised that I built my property portfolio before KiwiSaver was available and that, if it was around when I was younger, I would likely have not bothered with rental properties.
Although we went through a spreadsheet I created to complete cash flow analyses for prospective properties and discussed how taxation works, I quickly moved to KiwiSaver.
I have been in KiwiSaver since it was launched and described to my colleague the return on investment on my personal contributions since then. With the $1000 Government kick-start, employer contributions, annual tax credit and fund appreciation, I have made a return unlikely to be matched by anything other than winning Lotto.
My only caveat is that I'm uneasy with government tinkering that runs the risk of reducing the attractiveness of KiwiSaver if the rules are changed often enough.
Hopefully, I have given my colleague some sound advice.
A: Basically, yes you have. KiwiSaver is a good deal. However, you might have painted somewhat too rosy a picture.
In the first years of membership, the return on your personal contributions to KiwiSaver is indeed terrific. But the effect dwindles over time.
The first year is outstanding, because of the kick-start. Some examples:
• On a part-time income of $20,000, you put in $600, your employer puts in $495 after tax, and the Government puts in the $1000 kick-start plus $300 tax credit. Total inputs are $2395, almost four times your input.
• On $60,000, you put in $1800, your employer puts in $1260 after tax and the Government puts in $1000 plus $521. Total inputs are $4581, more than 2.5 times your input.
• On $100,000, you put in $3000, your employer puts in $2010 after tax, and the Government puts in $1521. Total inputs are $6531, more than twice your input.
The deal is particularly good for people on low incomes, partly because of the $521 tax credit cap. But still it's super for everyone. And on top of the numbers above, you also get the return your fund earns - typically 2 to 10 per cent.
In subsequent years, you don't get the kick-start. Still, the contributions of someone on $20,000 are more than doubled by their employer and the Government. For someone on $60,000 they are almost exactly doubled and for someone on $100,000 they are close to doubled. And, again, you add the return your fund earns.
If you have twice as much going into any savings, you'll get twice as much out at the other end. It's powerful stuff.
However, there's another effect that applies to any regular savings plan over time. As your KiwiSaver account grows, the amount that goes in - boosted by employer and Government contributions - has less and less impact each year, while the return on your fund has more and more impact. How come?
Let's say you earn $60,000 and contribute $1800 each year. That is approximately doubled by your employer and the Government, so we'll say total contributions are $3600. Let's also say you're in a higher-risk fund with an annual return averaging 5 per cent after fees and tax.
• When your savings total is $10,000, the 5 per cent return will be $500 a year. That's dwarfed by the total contributions of $3600.
• But once the savings total is $100,000, the annual return will be $5000 - more than the $3600 of contributions.
• And once your savings total is $1 million, the annual return will be $50,000. Next to that, the $3600 of contributions doesn't make all that much difference. The main driver of growth is the 5 per cent return.
So if you look at how your KiwiSaver account has performed in the current early days, it's fantastic. The extra contributions make a big difference. But decades later - when the extra contributions matter much less than the fund return - the performance won't look quite so marvellous.
An actuary friend crunched the numbers. In the scenario above the effective annual return is 37 per cent over 5 years, 19 per cent over 10 years, 11 per cent over 20 years, 9 per cent over 30 years, and 7.7 per cent over 40 years. Over 47 years - the maximum anyone can earn tax credits in KiwiSaver, from age 18 to 65 - it's 7.3 per cent.
Still, 7.3 per cent after fees and taxes is not to be sneezed at.
Could rental property beat it?
In some circumstances. Pretty much everyone borrows to invest in rentals, at least at the start. That means that if things go well, you get the growth not only on your money but also the bank's money. Returns can be high.
But if things go wrong and you're forced to sell in a down market, you can lose all your savings and still owe the bank.
KiwiSaver is considerably lower-risk, even in a high-risk fund. The worst scenario is that the market plunges and so does your balance. But if you don't panic and switch to a low-risk fund, it will almost certainly recover - given the wide range of assets you're invested in.
You get what seems to be impossible - high returns for moderate risk - simply because of the employer and Government contributions.
KiwiSaver is also a lot less hassle than rental properties.
On your concerns about future governments changing KiwiSaver, there are no guarantee they won't. But if you don't like a change, you can always take contributions holidays through until you retire - and just leave your account to grow through annual returns.
One last - but important - point. Everyone in KiwiSaver should note that, as your account balance grows, returns matter much more than contributions. If you've started in a low-risk, low-return fund, it doesn't make much difference in the early years. But as your account gets bigger, consider moving to a higher-risk, higher-return fund if you have more than 10 years before withdrawal. You'll suffer losses some years, but almost certainly end up with more money.
A KiwiSaver convert
Q: When KiwiSaver was first announced, I was very anti: it's my money, how dare they tell me who I have to invest it with and when I can take it out and use it, etc. But now I am a firm proponent of it.
On good advice from our adviser, I reluctantly joined KiwiSaver 2.5 years ago as he argued that my current retirement savings plan could be used from a potential early retirement to age 65 and KiwiSaver savings could be used after 65.
Looking at the results, I wonder why it took me so long to join KiwiSaver. My current balance is $16,500 and I have contributed $6500 - a measly 39 per cent. Where in the (legal) world can you get a consistent return of 150 per cent on your investment?
Based on my experience, I am spreading the word to family and friends that they should be in KiwiSaver if they possibly can - it just doesn't make sense not to.
A: I hate to burst the bubble. But, as explained above, your really high return will gradually decrease over time. Still, you haven't put your family and friends wrong. KiwiSaver is worth being in.
Buying before you travel
Q: We had the same dilemma in June 2012 as the young guy in your column last week. We wanted the flexibility of travel but also to mitigate the risk of house prices going up beyond what we could afford on our return.
We had a deposit of $200,000 and ended up buying a house at $450,000 in November 2012. Its rent covered the fixed costs with about $80 a week spare. We had hunted for five months solidly via TradeMe and eventually concluded the Birkenhead/Glenfield area was the only suburb close to the city where the rental yield stacked up over the purchase price. We have "saved" $50,000 to $90,000 by buying before we went travelling and not on our return a year later.
We also bought at a comfortable level, so if we had a nightmare overseas (major injury to one of us) we could pay the mortgage with one income. So we think we split our risk of house price rises and mortgage rate increases by entering the market at a medium risk level rather than maxing out on a $700,000 property.
It meant a smaller house, but now we are home and very happy with our little lifestyle and very glad we're not buying now.
I'd recommend this young chap does the same - buy at a low-medium level house price to mitigate some of the risk of house prices rising too much above your ability to save, while being able to spend 100 ($200) on a night out and not feel like he will be broke when he comes home.
Travel is fantastic, but you don't want to get home and be in the situation where the same house will cost you $50,000 to $90,000 more than when you left. This is unfortunately a reality in the NZ housing market. You can do both, and keep the $30,000 savings to travel with. You'll have a ball!
A: I agree with some of what you say, but not all of it. The good advice is that if the young man - or anyone else in that situation - decides to buy a house before travelling, he should get a relatively modest place with a good rental yield. That makes things easier if something goes wrong and he's still in the housing market.
I'm still not convinced, though, that he should buy a house at all at this stage. There are two key differences between your situation and his:
• You're obviously a couple. The young man, on the other hand, used the word "I". This suggests he plans to travel without a partner - so there's a reasonable chance he'll fall in love with a foreigner and want to settle down elsewhere. Who knows whether the relative house price trends in that country and New Zealand will work in his favour? Same goes for the foreign exchange rate. It's risky.
• You're looking backwards. New Zealand house prices rose lots while you were away but that's all the more reason to think that trend might not continue. As I said last week, the OECD reckons our house prices might fall.
• Thanks for writing, but I'm sticking with my recommendation that he doesn't buy before travelling.
• Mary Holm is a freelance journalist, member of the Financial Markets Authority board, director of the Banking Ombudsman Scheme, seminar presenter and bestselling author on personal finance. Her opinions are personal, and 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@example.com or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice.