Laddering a mortgage is actually playing it safer than putting your whole loan on one term. Photo / 123rf
OPINION
Q: Long-time readers, first-time writers! Like many, we are trying to work out the best way to refix our mortgage, and the six-month fixed term is about to expire in a couple of weeks at the end of the month.
Our questions are: with the interest rates looking like they are going to continue to drop, would laddering the mortgage, as you have suggested with term deposits, work? We would fix one-third for six months, a third for 12 months and the balance for 18 months, and then keep refixing them for 18 months.
Would the laddering work like it does for term deposits, especially in a market where interest rates are falling? Would the fact that the principal reduces on a mortgage but increases with compounding interest for a term deposit make a difference to the results? Or should we just “play it safe” and fix the whole amount for the shortest term possible?
A: Laddering a mortgage is actually playing it safer than putting your whole loan on one term. This applies regardless of whether interest rates are moving up or down. And, by the way, the same goes for term deposits.
The point is that nobody knows how fast and far interest rates will fall or rise. In the current market, you might pay 7% on a one-year term or 6.5% on a two-year term. Two years looks better. But a year from now, the one-year rate might be well below 6%, making two one-year terms a better deal in total. On the other hand, rates might not fall much, and you’ll wish you had taken the two-year deal.
When interest rates are rising, the choice might be one year at 5% or two years at 5.5%. If, a year from now, the one-year rate is 6.5%, you’ll be sorry you didn’t go for two years. But if it’s 5.7%, you’ll be glad you stuck with one year.
What to do? Take a bet each way by splitting your loan – or, as you are proposing, take a three-way bet.
It’s true that by laddering, you remove the chance that all of your loan will look good a year from now. But you also remove the chance it will all look bad.
Psychological testing tells us that people dislike a loss more than they like a gain of equal size. So most people are willing to give up on the chance of getting the whole lot right in exchange for knowing they won’t get the whole lot wrong. It’s a type of diversification.
Another advantage: in your plan, you’ll have a third of the money maturing every six months. You never know when you might suddenly receive more money, perhaps from Lotto or a gift or inheritance, and you can use it soon to repay a lump sum without penalty. Or maybe you get a big pay rise and, when a mortgage term ends, you can increase your regular mortgage payments.
One more thing: I keep hearing of people getting lower mortgage rates by asking their bank if they can do better, and telling them of better deals available elsewhere. Be a bit pushy.
Q: I am hoping you will know this or find out? I have tried but with no luck. Profits from Lotto have been a topic of late, but I did hear that grants do not come from online Lotto, only shop purchases in New Zealand. Those online profits go to where? Australia? Would you know?
A: There’s no transtasman grab. “I can reassure your readers that all Lotto NZ’s profits – whether from instore and online channels – are transferred to the New Zealand Lottery Grants Board for distribution to New Zealand community causes,” says CEO Jason Delamore. “None of our profits go offshore to Australia or anywhere else.”
Q: Re the distribution of the money spent on Lotto tickets discussed last week - 53% prizes, 6% operating expenses and 25% community grants – that still leaves 16% unaccounted for. Possibly could this go directly to the Government? Would be interested to know. Based on an approximate, very quick calculation, I suggest that this is around $4 million to $5m per week. PS I still buy a ticket every draw – which, based on my historical returns, is madness.
A: Most of the remaining 16% – 12% – does indeed go to the Government, as taxes. The other 4% goes to retailer commission and MyLotto transaction fees, says Lotto NZ.
And yes, buying a ticket is madness if you define it as an investment. But perhaps you could call it entertainment!
Q: It’s not often I disagree with you – but on last week’s Q&A about focusing on share returns for less than a year, I must.
You have totally ignored the fact that many investors focus on dividends, not just capital growth.
Monitoring annual results, in effect the level of dividend payout announced every six months, is thus very important.
Chorus for example has gone from a zero dividend in 2015 to 47.50 cents per share this year, with 57.50 cents guidance next year.
Buying Chorus 10 years ago has delivered an IRR (internal rate of return) of over 18% – far in excess of what many fund managers have managed, despite it being a regulated monopoly with very low risks.
An IRR of 18% means that the average return – dividend plus capital appreciation – each and every year has been over 18%.
I will continue to watch the results every six months, as will many who focus on dividend yields.
I don’t see this as silly – but a very successful investment strategy!
A: Oh dear. Last week I said, “Taking much notice of the performance of any volatile investment over less than a year is silly. (Sorry!) Returns are all over the place.”
Returns on shares are made up of dividends – your share of the company’s profits – and gains or losses in the share price. And I didn’t mean you shouldn’t take an interest in those numbers. Of course you should, if you want to.
The worry is when people assume the returns over a year are likely to continue, and buy or sell shares on the strength of that – or, in the case of last week’s correspondent, choose to invest in several individual shares rather than a share fund.
As I said, investing directly in a handful of shares is not a bad idea. But there’s less diversification, which means more volatility. And it seemed that he thought he could pick shares that would beat the market over the long term. Nobody – not even the professionals – can do that consistently.
Generally, dividends are steadier than movements in a share price. And some investors – perhaps including you – tend to buy shares that usually pay high dividends and hold them for the long term, using the dividends as income.
By contrast, if you invest in a KiwiSaver or other managed fund, your dividends are reinvested, helping your balance grow. And many investors in individual shares also have their dividends reinvested.
Using dividends as income can work well, but you take two risks. One is that the dividend flow won’t continue because a company’s profits have fallen. The other is that when the shares are ultimately sold – which may be after you die, but still – the price may have fallen, or gained little. Companies that pay big dividends tend not to grow as fast as the ones that keep their profits to reinvest in growth.
Years ago, a friend and I were comparing the way we had invested some savings for our children. I was using an international index fund. He was using shares in a stable New Zealand company with a track record of paying higher dividends than the returns on my fund. Until it didn’t. Unexpectedly, things went wrong for the company, and his kids’ savings plunged. Mine, in a widely diversified fund, chugged on.
The very example you give, of Chorus, illustrates how volatile dividends can be. You give an impressive return since the dividend was zero in 2015. But that’s a classic example of cherry-picking a period to make an investment look exceptional. Before that, in 2013, the dividends had been 25.5 cents a share. Investors moving from there to zero in 2014 and 2015 would have been far from happy.
I assume you invest in a range of companies, to reduce that risk. But in economic downturns, many companies may cut their dividends. That might be okay if you have other sources of income. But it’s something to be aware of.
Your choice of Chorus to write about is also a classic example of the benefit of hindsight. Looking back, anyone can name shares that have performed “far in excess of what many fund managers have managed”. The trick is to know which ones will outperform in future. As I said above, good luck with that.
Footnotes:
Q: Since the birth of our first grandchild three years ago, I have wanted to invest a regular amount each week or so – while my wife and I are still working – towards an education or other fund for whatever would best benefit them, as a child may also suffer poor health and require support.
We are not in a position to invest a lump sum upfront in order to get the better term deposit rates. We’re also not wanting to pay fees for a share fund, as we are already paying fees in our Milford KiwiSaver Growth funds.
As we have less than 10 years to retirement, we decided to increase our own KiwiSaver contributions from 3% of our pay to 8%, effectively investing the extra we had intended to. And from age 65, we can distribute the approximately $10,000 for each grandchild as intended. Our intentions may need to be written in our wills also?
A: Good on you. I see nothing wrong with what you’re doing although, yes, I would include these plans in your wills, just in case you die before turning 65.
A couple of points to note:
For example: If the fees are 1%, and you have $10,000 in one fund and a grandchild has $1000 in another fund, the total fees will be $100 plus $10, which is $110. If the $10,000 plus $1000 was all in one fund, totalling $11,000, total fees would be the same: $110.
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 mary@maryholm.com or click here. 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.
The average person is still paying 6% on their mortgage.