Mary Holm on investing

Mary Holm is a personal finance writer

Mary Holm: No excuse for loan-dodging students

57 comments

It's taxpayers who foot the bill - again - when graduates do a runner.

Compared to other OECD countries, New Zealand's tertiary students get a good deal. Photo / Thinkstock
Compared to other OECD countries, New Zealand's tertiary students get a good deal. Photo / Thinkstock

I just want to write to you and tell you how much I agree with your recent note on student loans.

A lot of people have no idea of the real cost of education here in New Zealand, and that the whole system is already subsidised by the Government, our rates and taxes.

To think that a student can leave the country after three to five years at uni here and not pay back their loan - [that] is so irresponsible. Go Mary!

"Go students", is more like it - off to far away countries and the dream that they can escape their student loans. But the Government is getting stroppier about getting those loans repaid. And so it should be. It's taxpayers' money.

Students also get heaps of other government support, as you say.

"As a rule of thumb, it is 30 per cent of the total study costs which students pay directly through their tuition fees," says a Treasury official. "The other 70 per cent is covered through student subsidies by the Government."

How does that compare with elsewhere? Our 70.4 per cent was just above the OECD average of 68.9 per cent in 2008 - the most recent data available. But it's well ahead of the countries we usually compare ourselves with. In Australia, 44.8 per cent of spending on tertiary education came from public sources in 2008. In the UK it was 34.5 per cent, and in the US it was 37.4 per cent.

While we're at it, it's interesting to note that New Zealand topped the OECD - at 5.5 per cent - for the percentage of total public spending that went to tertiary education in 2008. Again, we were well ahead of the "usual suspects".

In Australia it was 3 per cent, in the UK it was 1.7 per cent and in the US it was 3.2 per cent.

Okay, today's students aren't as lucky as the baby boomers, whose university studies were practically free. But let's not get into inter-generation comparisons. They're horribly complicated, and just lead to parents and kids saying nasty things to one another.

The fact is that today's tertiary students get a good deal. To avoid repaying their student loans - especially when they are overseas so New Zealand is not benefiting from their education - is ... well, let's just say that perhaps they should make an ethics course compulsory for every degree.

Fixed-interest assets

As I am in my 50s, I chose a balanced portfolio for my KiwiSaver account, thinking it would be less risky as the investments would be a mix of returns on shares and fixed interest.

I noticed in my monthly report that my fixed-interest investment was showing a negative return. I thought fixed interest meant you always got a positive return, albeit a lower return than on a more risky investment.

I don't understand my KiwiSaver provider's response to my querying this: "Fixed interest is an asset and can be traded in a similar manner to shares. Therefore the value of a fixed-interest asset can decrease in value depending on the market value. For example, if a bank interest rate is higher than bond rates, then the value of bonds can decrease."

So does this mean they're trading my fixed-interest investment? And does this also mean "balanced portfolio" is not what I thought I had signed up for?

You're right that a balanced portfolio will be less risky than one that holds only shares and/or property. It will also hold fixed interest and probably some cash, and the returns on both of those are usually less volatile - although they are likely to be lower than on shares and property over the long term.

What's more, the fact that a balanced portfolio holds a variety of assets reduces the expected volatility of the fund. When one asset does badly, another might well have a good year, offsetting the bad returns.

I can understand your confusion about fixed-interest assets, which are usually bonds issued by a company, bank, government or other issuer.

When you buy a newly issued bond, you give the issuer some money for a period, for example $10,000 for five years. The issuer pays you interest, say 5 per cent a year - usually in instalments over the period - and pays back the $10,000 at the end of the five years.

One way you could lose money is if the issuer gets into financial trouble and doesn't pay the interest or repay your original investment. But there's also another more common way.

Let's say that after three years you decide you want to get your money out early. To do that, in most cases you have to sell the bond to someone else. They might then hold it or resell it, and whoever owns it at the end of the five years receives the repayment of the original $10,000.

How much will you get for your bond? That depends on what's happened to interest rates in the meantime. If other similar bonds at the time are paying just 4 per cent, the buyer will find your 5 per cent bond attractive and offer you more than $10,000 for it. But if other bonds are paying 6 per cent, your bond won't be very appealing, and you would expect to get less than $10,000 for it.

Most New Zealanders who buy bonds directly don't sell them, but hold them to the end - called the maturity date. So they don't make gains or losses on them. But a KiwiSaver fund that holds bonds has to value its bonds each day as if it were selling them. This is known as "marking to market". In the process, they will make some gains or losses on paper.

Marking to market is necessary for a couple of reasons:

•At times, some investors will be withdrawing money from the fund - perhaps to put into their first home. Meanwhile, others are putting money in. It's important that their investments in the fund are correctly valued at current prices, to be fair to them and to the remaining investors.

•All investors should always be able to find out what their investment is worth if they withdraw their money that day.

Bond funds, or KiwiSaver funds that hold bonds, do also trade them sometimes. And that can turn paper losses into real losses, as well as adding trading costs.

So, to answer your question, your fund may or may not be trading its bonds. Any fund that holds bonds will sometimes suffer losses, whether or not it trades.

I wouldn't worry about this. The values of bonds, shares and property all fluctuate, but returns have always trended upwards over the long term.

However, we never know just how long the long term will be in future. If you are concerned, you could switch to a conservative fund that holds largely cash. Cash includes term deposits and similar, usually with a term of a year or less. These can't be traded. So - unless the issuer of the deposits defaults and doesn't repay them - you won't make losses in cash.

Rental deduction

In your reply to the person last week asking about a new home and large mortgage, they said they may retain the old home with no debt as a rental.

A reminder about structuring correctly re non-deductible and deductible debt would have been a good idea.

That Q&A was too long already, and was about another issue. But you make a good point.

If the couple rent out their old mortgage-free home and take out a mortgage to buy a new home, that's not clever tax-wise. They wouldn't be able to deduct the interest on their mortgage, whereas if the mortgage were on the rental property, the interest would be deductible.

That's why anyone who has mortgages on both their home and a rental should always make any extra payments off the home mortgage. It's better to get rid of the non-deductible mortgage and keep the deductible one.

This couple, though, is a bit stuck. What's relevant is the reason someone takes out a mortgage, and they would be doing that to buy their new home. They can't just say: "We'll switch the mortgage and say it's on the rental property."

However, all is not lost. They could set up a company - which can be done fairly simply at the cost of $153 - and sell the old home to the company, says PricewaterhouseCoopers partner Scott Kerse.

The company would take out a mortgage to buy the home and rent it out. The interest on that mortgage would then be deductible.

Meanwhile, the couple would receive the proceeds of the sale from the company, and use that towards buying their new home.

The result: the old now-rental property would have a tax-deductible mortgage on it, and their new home would have a smaller non-deductible mortgage.

The company would have to be set up as a look-through company, so the couple would almost certainly have to use an accountant. But the mortgage interest deductions should more than cover the costs of doing that - especially given that the costs of the accountant would also be deductible.

Kerse points out that if you make a financial move solely to avoid paying tax, you can get into trouble with Inland Revenue. "If, however, the couple decided they didn't want to expose themselves personally to any risk from the rental venture" - such as being sued for something by a tenant - that would be a legitimate reason to start the company.

In many situations, I'm not happy about people setting things up so they pay less tax. But in this case it doesn't seem fair that one person with a home and a rental gets one deal and another with a home and a rental gets a different deal.

And Kerse feels confident that Inland Revenue wouldn't look askance at this sort of set-up. "This issue was covered in a recent IRD publication [Tax Information Bulletin Vol 23, Issue 10 December 2011], under 'Questions We Have Been Asked'," he says. The department's answer was that the interest deductions would be allowed.

Budgeting advice

I have a son-in-law and daughter in Upper Hutt who need help in budgeting and managing their finance. Are you aware of experienced people that can work with them, over and above books such as yours?

Yes - and it's free. The NZ Federation of Family Budgeting Services gives advice by phone, online or face-to-face. They offer services all over NZ, including Hutt Valley. See www.familybudgeting.org.nz

Mary Holm is a freelance journalist, part-time university lecturer, member of the Financial Markets Authority board, director of the Banking Ombudsman Scheme, seminar presenter and best-selling author on personal finance. Her website is www.maryholm.com. 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 any reader may suffer from following it. Send questions to mary@maryholm.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.

- NZ Herald

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