KEY POINTS:
Q. In these troubled investment times, with shares tanking and finance companies failing, bank term deposits look more and more appealing.
I have been told twice recently by experienced financial people that putting your money on bank term deposit is actually devaluing your money. I was always led to
believe that if interest rates after tax were running ahead of inflation you were doing well. With bank deposits running at about 9 per cent and inflation at 3-4 per cent, that would appear to be the case. I would be interested in your opinion.
I don't suppose those financial people were trying to sell you some alternative investments to term deposits, were they? If not - if they genuinely believe what they told you - we've got to wonder how helpful all their experience is.
You are right. What matters is your return relative to inflation. And currently, far from being devalued, term deposits are growing in real value very nicely thank you.
This wasn't always the case. Through all the 1970s and early 80s, inflation was higher than term deposit rates. In the mid 1970s, the difference was huge, with inflation around 17 per cent and deposit rates around 7 per cent. Savers were seriously losing value.
But ever since the late 1980s, the situation has been reversed. Perhaps that's the problem for your "experts". They haven't looked around for 25 years.
Q. I was reading Brent Sheather's article "Applying the theories to KiwiSaver" in last Saturday's Business Herald, and he mentions that we should not be expecting long-term growth in shares similar to the past, as the return on shares has changed significantly. I have invested a sizable portion of my retirement planning in "Growth" or "Balanced" funds, on the belief that shares are a good investment for the long term. But he quotes an expert as saying he expects the real return on shares over the next 10 years to be " ... 7 per cent minus 2.5 per cent (fees) minus 2.3 per cent (inflation) - that is, just 2.2 per cent a year". That is a really marginal return. I can get twice that return from term deposits now "tax-paid"; that is, 10 per cent minus 2-3 per cent tax minus 4 per cent inflation = 3-4 per cent per year net.
So should we be diversifying - 30 per cent shares, 30 per cent property, 30 per cent interest, 10 per cent cash - or not? Given that property is not so good these days, I should simply place all the money in diversified term deposits to get a better return long-term. Or is Brent Sheather wrong?
Brent is not wrong. He is merely reporting what experts have said. But nor does he conclude you should move your long-term savings into bank term deposits.
As stated above, bank term deposits are paying unusually high rates these days, relative to inflation.
And shares and property have performed badly lately.
Still, over the long term we would always expect shares and property to bring in higher average after-tax and after-fees returns than term deposits.
That's how markets work. If shares and property didn't do better than term deposits, few people would want to invest in them. That would force their prices down. And the cheaper they are to buy, the higher the returns will be for those who do purchase.
It's true that many experts predict lower future share returns than in the past. But returns on property, bonds and bank term deposits are also expected to be lower. The levels change but the long-term relativities between the different assets are not likely to. They certainly haven't for the many decades of information we have.
While a move to term deposits might look attractive right now, I would be surprised if you still felt good about it 10 or 20 years from now. I'm sticking with shares for the long term.
Q. In your response to the first question in your column last week, regarding "traps in renting out your house", I believe your advice is incorrect on two counts: 1. You say that "you won't be able to tax deduct your mortgage interest. The deductibility depends on why you took the loan out in the first place, and that was to finance your home, not a rental property". My understanding is that the interest will be deductible on the grounds that it was incurred in producing assessable income. This situation applies to thousands of Kiwis who head off overseas for a few years and rent out their own home while they are away. 2. In relation to depreciation you say "if the house value grows while you are not living there, you would have to pay back the depreciation when you move back in". However, even if the value were still the same when you moved back in, the depreciation would still need to be reversed and shown as income. You have correctly pointed out that if the property declined in value, then the depreciation recovered would be reduced by that amount, possibly eliminating it. I trust you will be able to correct the advice in your next column.
I certainly would correct it if it were wrong. And I suppose, strictly speaking, your second point is right. But talk about picky.
Your argument holds only if the house value is exactly the same, to the cent, when the woman moves back into her house as it was when she moved out. What's the chance of that?
I gave scenarios in which the house value increases or decreases and, as you have acknowledged, both of those were correct. I think that covered the possibilities just fine.
On your first point, what I said is correct. Whenever I write about technical stuff like this, I always get experts to check it for accuracy. This time they were PricewaterhouseCoopers tax partner Scott Kerse and an Inland Revenue official. Their opinions are good enough for me.
It does seem, though, that people often get this wrong. I just hope those thousands of Kiwis don't get audited.
Q. Just a comment on the answer to your first question last week. I don't think it's correct that the woman's mortgage interest would not be deductible. If the loan was taken out to buy or finance the home, then the loan relates to or stays with anything dealing with the house. Thus if it becomes rented then it makes the interest incurred in deriving the assessable rental income directly related and tax deductible. It would be a different matter if the mortgage was taken out over the house throughout the years of ownership to, say, purchase a new car, overseas travel or some other property. Then it would NOT be tax-deductible if the house was rented out, as it does not relate directly to the house in the earning of its assessable income.
Nice try. Your argument is somewhat more sophisticated than the previous correspondent's. But it still doesn't wash with Inland Revenue. The only thing that is relevant is the reason for borrowing when the loan is taken out, says the department.
Speaking of sophistication, there are various ways that people get around the non-deductibility of interest when they rent out a home they previously lived in, involving family trusts, LAQCs and so on. I discussed this with Scott Kerse. But in the end we decided that in the woman's circumstances it wouldn't be worth her while to go to the trouble and expense.
Kerse now adds a bit more. "None of this is simple. Tax deductions for mortgage interest on a pre-existing mortgage may well be available where the property owner can demonstrate a fundamental and complete change in the use to which the property (and therefore the mortgage) is put." That would mean - at the very least - that the owner had no intention of coming back to live in the house.
Even then, though, Kerse warns, "IRD have a different view of the world. Homeowners would do well to keep that in mind.
A dollar or two spent on some professional advice upfront could well repay handsomely in avoided tax penalties, interest and stress!"
Q. Further to the first letter in last week's column, I know a woman who was in a similar situation to your correspondent and she rents out her house and then house-sits in other houses. She has found, particularly at this time of the year, people go to the UK or US for up to six weeks. Quite often they have a pet they want looked after, as well as liking to have someone in the house while they are away. If your correspondent belongs to any clubs, works for a large organisation, or asks friends, she could easily spread the word. The woman I know also has an accommodating brother who is quite happy for her to stay in between "sits" and just contribute to her board and keep. Food for thought.
Great idea for the right person. You would have to cope with not having a fixed base - something I suspect many people would struggle with. I suppose, though, the brother's place or an equivalent would be a sort of base.
And on the plus side, there would be lots of variety. And at least some of the temporary homes could be quite luxurious.
It might well be something to try. If it doesn't work out, our correspondent could always go into rental accommodation at that point.
Mary Holm is a seminar presenter and author. Her website is www.maryholm.com. Her 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 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.
