Putting a little money away each week eases path to higher savings
A spare $50 or $100 a week can make a huge difference to your long-term wealth. It's not as difficult as some people think to put a little more away each week. Drip-feed that into an investment and it soon adds up.
Readers get indignant when I suggest there are easy savings to be made in most people's budgets. Yet $100 a week is the booze and takeaways bill for some households.
Social research by RaboDirect has found the "cut back to save" message doesn't really work. The average buffer for the over-50s is $5000, says Matt Gardner, marketing manager at RaboDirect.
If that money had drip-fed into investments or interest-bearing accounts instead of remaining as a "buffer" in their current accounts it could be earning money instead of being eaten away slowly by inflation.
One of the very best investments people can make is paying the mortgage or other debts off faster.
In simple terms, paying $200 a month extra into a savings account might return 3.5 per cent. By overpaying the mortgage you're saving the equivalent of the interest rate, which currently is likely to be about 5.75 per cent.
What's more, the latter is tax-free whereas the 3.5 per cent return on the savings account is taxed.
Be sure before making extra payments that you're not penalised for overpaying. If you're on a fixed interest rate mortgage, loan, or HP agreement, your lender might charge you for overpaying.
KiwiSaver is one of the most obvious investments to drip-feed extra savings into. If you're contributing the 2 per cent minimum through your employer and earning less than $52,000 a year you will miss the threshold to claim the total $521 member tax credit a year, says David Boyle, general manager of funds management at ANZ Wealth.
Employees can choose to pay 2 per cent (3 per cent from next April), 4 per cent or 8 per cent into KiwiSaver through the payroll. Anyone can contribute an amount of their choice over and above PAYE deductions directly to the fund via direct debit.
The advantage of saving more in KiwiSaver is that your retirement savings are growing. Another advantage or disadvantage, depending on which way you look at it, is that you're locking the money away until retirement.
Not everyone wants to lock up those extra savings long term and many fund managers as a result now offer regular managed funds that mirror the KiwiSaver funds. That means if someone is invested in the ANZ balanced KiwiSaver, for example, he or she can put additional money into an identical balanced managed fund that is unlocked. The only difference is that the fees charged on the managed fund are a bit higher. There is, however, no KiwiSaver member fee.
Extra savings do add up. An extra $200 a month invested into a sharemarket-based fund at an average 6 per cent a year return, paying 17.5 per cent Pie tax and with 3 per cent inflation, would be worth $24,000 after 10 years.
History shows that despite poor markets such as we've had over the past decade, money invested in the stock market grows over time at a faster rate than if left in the bank.
One advantage of drip-feeding straight into a fund rather than building the money up in a savings account is the reduction in administration. It's too easy to not get around to making that investment or being hamstrung by indecision of what to do with the larger sum that has built up.
Drip-feeding money into investments has the benefit of dollar cost averaging. You buy more shares or units in the months when the price is down and fewer when prices rise. You reduce the risk of investing just before markets drop by spreading the investment out over the year and smoothing out the volatility.
In the past it wasn't easy to drip-feed small amounts of money into investments. Some fund managers wanted minimum investments in the thousands of dollars. Since KiwiSaver launched, fund managers have built up new systems that allow them to accept small sums of money on a regular basis.
These days the minimums can be low. For example, the minimum regular payment at OnePath is $15 a fortnight and in ANZ's funds is $25 a fortnight. NZX's Smartshares exchange-traded funds have a minimum regular investment of $50 a month, which is still relatively low.
There is more than one reason to drip-feed money into investments. History has proven that you're better off to be in the market than out of the market, says Katrina Kruger, past president of the CFA Society of New Zealand.
What's more, the risk of investing a lump sum is that the market might drop immediately afterwards. "This is just another way of prudently averaging out the volatility in the market by investing on the 20th of every month," says Sam Stanley, head of Smartshares at NZX.
The alternative is to try to pick the top and bottom of investment markets that even experts can't do. One, whom I won't name, was renowned for saying: "The only thing you should be picking is your nose. You shouldn't be trying to pick the top or the bottom [of an investment market]."
Another reason to drip-feed investments as money comes to hand is that it's motivating to see the balance grow through regular savings. Sadly the savings habit that kids used to learn with their piggy banks and school banking has been lost, says Boyle.
KiwiSaver is starting to change that. Kiwis who began saving small amounts five years ago now have thousands and sometimes tens of thousands of dollars in their retirement savings. This is a king's ransom to anyone who hasn't saved before.
Cost savings are another big reason to invest by drip-feed. Many of the fund managers that welcome drip-fed investments have no or low entry fees for investment. For example, someone who buys Smartshares on the NZX exchange will pay a brokerage fee. If they drip-feed the money through a regular payment plan there are no upfront fees. Stanley says customers can start and stop their direct debits whenever they need to, which is useful if you have a big expense coming up and need to divert those savings.
ANZ's managed investment funds have no entry and exit fees, says Boyle. And the 40 funds from a variety of managers available through RaboDirect pay a reduced entry fee of 0.50 per cent if bought through a regular investment plan.
There is a small tax bonus for money paid into funds classified as Portfolio Investment Entities (Pies), such as KiwiSaver and many managed funds. The money drip-fed in will be taxed less than it would be in a regular bank account. On small investments the difference may be tiny, but over time those amounts add up.
Another option for investing regular monthly sums is Bonus Bonds. There are no entry and exit charges, which means that when a decent sum has mounted up you could invest it elsewhere. In the meantime any winnings are tax free.
I'm not a huge fan of Bonus Bonds, but they suit some people. If you look at the average return on investment - currently 1.75 per cent net - you'd be better off putting the money in a term deposit, high-interest savings account, or shares/funds.
There are, of course arguments against drip-feeding. A study for the CFA Institute by Singer and Mann found that since 1926 investors who drip-fed their money had done better in poor markets than they had in typical or strong markets. However, this presumed that the investors had put a lump sum in at the beginning of the year. They may not have had that lump sum to start with, which is why they were drip-feeding the money.
On the other hand Kruger cites research done for the CFA Institute by Dunham and Friesen which says that although dollar cost averaging can be suboptimal, it is easy to implement and removes emotion from the investment process.
There will always be those in favour and those against drip-feeding but it's a strategy that works well for many.