Mary Holm: Invest or save - it's a question of risk

It's also important to mind the gap between inflation and the return you receive, such as from term deposits. Photo / Getty Images

Whether to try for higher returns depends largely on when you need the money and your appetite for volatility.

I am a widow turning 65 shortly, own my own home mortgage-free (worth about $460,000), working 12 hours a week, semi-supporting my son who is at uni. I own a 10-year-old car with low mileage which runs perfectly. I have about $8000 in KiwiSaver and $35,000 in a bank investment earning 4 per cent a year.

I expect to continue working in the short term at least; the job is not physically demanding and I feel valued doing what I do (social work). By the way, I am on $22 an hour for the 12 hours.

My question: do I continue as I am or would the money in the bank, as well as the KiwiSaver money, be better invested elsewhere for better returns? I do not expect to inherit any money at any stage so don't anticipate my income increasing any time soon. Your advice will be much appreciated.

In the London Underground, there are famous signs telling you to "mind the gap" between the platform and the train. When it comes to investing, it's also important to mind the gap between inflation and the return you receive - in this case on term deposits.

As our graph shows, from the late 1960s to the early 80s, inflation was higher - often much higher - than interest rates. It's extraordinary to think about it now.

In those years, if you put money in a term deposit for six months earning, say, 10 per cent interest, when you withdrew the money it bought less than when you deposited it - despite adding what looks like a great interest rate. Tax on the interest made things even worse.

These days, the 4 per cent you're getting seems pathetic compared with 10 per cent. But it's actually much better. With inflation most of the time well below interest rates, you gain in buying power - although tax still means you don't gain much.

Whether you should try for a higher return depends largely on when you plan to spend the money - and also on your appetite for risk.

If you can't cope with the idea that your balance might sometimes go down, I suggest you leave the money in bank term deposits, including the KiwiSaver money. (I'm assuming you've been in KiwiSaver at least five years so you have access to that account.) Shop around - on interest.co.nz or depositrates.co.nz - for the best rates offered by banks.

But if you could handle some dips, knowing that in the long run you'll probably get higher returns, you could move the money you don't expect to spend for six or seven years or more into a balanced fund - which typically invests about half in bonds and half in shares.

A convenient way to do that might be through your KiwiSaver provider, which will probably offer balanced funds both in and out of KiwiSaver. Go for the balanced fund with lower fees.

Each year or so, withdraw some money from that fund, so that you always have spending money for the next few years in term deposits.

You could take even more risk, putting money you don't plan to spend for at least 10 years in a riskier fund. But in your circumstances, that feels a bit foolhardy.

By the way, if you're wondering about the two recent spikes in inflation, here's how the Reserve Bank explains them:

"The 2008 spike was mostly driven by a jump in tradables inflation.

"This was mostly due to the sharp drop in the New Zealand dollar that occurred in the early stages of the global financial crisis, which forced import prices sharply higher - most noticeably in higher petrol and food prices. You may recall when petrol went through $2 a litre and cheese $10 a kilo.

"The 2011 spike was mostly driven by the increase in GST on October 1, 2010. The increase from 12.5 per cent to 15 per cent directly added 2.0 percentage points to headline inflation and impacted on most prices - rents are a notable exception - which is why both tradables and non-tradables inflation spiked higher."

Surviving on Super

Having read your column since it started, I cannot recollect ever seeing a question about the following. How much capital would a 65-year-old need to provide an income equal to the current rate of NZ Super?

Let's start with the NZ Super totals. Before tax, a single person living alone gets about $1,830 a month, and a married couple with both qualifying gets about $2,770 a month.

The amounts rise each year at the same rate as average wages. The last increase, in April, was 2.66 per cent. So we'll assume that the payments on our other investment also rise by that much each year.

We'll also assume that you're going to spend the principal as well as the interest, so that the money is all gone when you die. That's a much more reachable goal than if you preserve the principal.

First, you have to estimate how much longer you'll live. At 65, the average person lives about another 20 years.

To be on the safe side, let's say you'll live 25 more years, until 90. If you're still alive then, you'll probably do fine with just NZ Super. Most people at that stage say it's enough.

If you invest the money at a return of 4 per cent before tax, you'll need about $465,000 if you're single, or $704,000 if you're a couple.

If you're prepared to take a fair bit more risk, and get an average return of 8 per cent before tax, you'll need about $302,000 if you're single or $457,000 if you're a couple.

However, a speaker at a recent seminar on "decumulating" retirement savings - run by the Retirement Policy Research Centre (RPRC) at the University of Auckland - said research found that few retired Australians are willing to use riskier investments. Our population is probably similar, so most people should use the 4 per cent numbers.

There are a lot of assumptions here, a key one being that NZ Super is unchanged. But it gives you a rough idea.

Those who want to plug in their own numbers could use the calculator at tinyurl.com/howlongwillmoneylast.

One of the problems with these sorts of calculations is that returns almost certainly won't stay around current levels, especially over 25 years. If they rise, you get more to spend, but if they fall you might be struggling.

Various ways to deal with this uncertainty were discussed at the RPRC seminar. They included: home equity release offered by Heartland Bank; a regular retirement income product to be offered next year by NZ Income Guarantee; and a proposal from RPRC co-director Susan St John called KiwiSpend, a state-run scheme that would give retirees an extra $10,000 a year, rising to $30,000 if they needed long-term care.

There's not room to go into detail here. Suffice to say the experts are aware that most New Zealanders find it hard to handle their savings in retirement. Hopefully help is coming soon.

Negative gearing

Last week you said, "You also make a good point about tax. It's fair that mortgage interest, rates, insurance and so on are tax-deductible for landlords. They need to be subtracted from income earned, just as in any other business. But capital gains - whether on property or shares or anything else - should be taxable."

No it ain't fair. In the case of negative gearing, the income that the loss is being deducted from is an unrelated salary that has nothing to do with the investment. If we treat a salary as a "business" then why can't we deduct transport costs, food, education costs, etc? These at least are costs directly related to maintaining the salary earner.

For the benefit of others, negative gearing is when you borrow to make an investment, and the income it earns isn't enough to cover the interest and other expenses, so you make a loss. It's common in the early years of a rental property investment.

Obviously, the investment works only if you make a big enough profit when you sell to more than cover the losses over the years. In the meantime, though, investors in New Zealand and some other countries can deduct each year's loss against other income, including salaries - and that's what's getting your goat, as my mother used to say.

Earlier this year Labour said that if it won the election it would "ring-fence" rental property losses so they couldn't be deducted against non-rental income. That idea has merit - although there are counter arguments. Your point about treating salary as a business could be part of that debate.

Let's just say that I didn't have negative gearing in mind when I wrote the paragraph you quote. By "income earned" I meant rental income.

• 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 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.