Money Matters: Investing for security and freedom

By MARY HOLM

Q. In my marriage settlement I have come out with $40,000. What would be the best way to invest?

I am in a de facto relationship which is shaky. I have no assets and I am no good at all with finance, so appreciate your help.

A. This is your big chance to change your no-asset situation - a change that can bring you both security and freedom.

You say you want to invest the money, so I'm assuming you're covering your everyday costs through work income, or some other way.

I'm also assuming you've got accommodation at the moment, with your partner. But that will last only if the relationship does and it sounds as if we shouldn't count on that.

The $40,000, therefore, should be kept available to buy a unit if and when you need it. It will not only give you shelter, but gets you into the housing market. If house prices rise later on, the value of your unit will probably rise too, so if you want to move you should be able to do so.

I doubt if you'll get a place mortgage-free for $40,000. But, if you stay outside Auckland and go for something small in an inexpensive area, you might not need too big a mortgage.

What to do with the money in the meantime? Firstly, keep it in your own name and don't mingle it with your partner's money. That avoids any possibility of him being able to claim a share of it if you break up.

Given that you might need the money within the next few years, I wouldn't put it into anything that can fluctuate in value, such as shares or property. Over a short period, there's too big a chance it will be worth less when you need it than it is worth now.

Stick with something simple, such as a bank term deposit. Unlike many alternatives, there are no fees. And currently the banks are offering pretty good interest rates.

Ring around the banks to get their rates - and don't overlook Bank Direct, BNZ Finance and AMP Bank, which tend to pay more.

The tricky question is how long you should tie up your money. These days, the longer the term, the higher the interest rate.

But what happens if you go into a three-year term deposit and need the money before that period is up?

Let's say you have to take it out after two years. Standard banking practice is for the bank to pay you the interest you would have got if you had had a two-year term deposit, minus a 2 per cent penalty, says Greg Shepherd, BNZ's manager of savings and term investments.

The bank will already have been paying you the higher three-year rate while you've had the investment. So it may have to take back the excess by reducing the principal it gives back to you.

It's quite a tough penalty, well worth avoiding.

Currently, BNZ's term deposit interest rates (on less than $50,000) are 6.8 per cent for three years, 6.1 per cent for two years, and 5.3 per cent for 90 days.

So, in our example, you would end up getting 6.1 minus 2 per cent, which is 4.1 per cent.

If you broke the term deposit after only three months, you'd get 5.3 minus 2 per cent, or just 3.3 per cent.

In either case, you would clearly have been better off just using a 90-day investment from the start, and rolling it over into another one each time it expired.

On the other hand, if you did keep the money in the bank for the full three years, you'd receive 6.8 per cent, which is probably better still.

We can't simply compare that with 5.3 per cent, because interest rates are expected to rise in the near future. So the 90-day rate may well go quite a lot higher within three years.

Generally, though, people who tie up their money for a longer period end up with a higher return. The market rewards them for committing their money.

Only you can judge the likelihood that you'll need your money sooner rather than later. You also know whether you could live with a friend or relative for a while, if needs be, until a term deposit matured.

If it all seems too complicated, just stick with 90-day term deposits and you can't go too far wrong.

But don't ever be tempted to spend the money as it becomes available, rather than re-investing it. As I said, it's a big enough amount that it could really make a difference to your life.

Q. In 18 months we have gone from "comfortably off" to "scraping to make ends meet". We're both 51, a professional couple with four daughters. I didn't work until the girls were all at secondary school.

All our spare cash was put into paying off our two big mortgages. We always hoped for a trip and a comfortable life when the girls left home.

Drastic changes the year before last: I was made redundant from my part-time job, then my husband had a heart attack and he was also made redundant.

We paid off the mortgage. Our only savings are $18,000 in the bank. We don't want to put it into a long-term interest account as we may need to draw on it, having no medical insurance.

Everyone says: "Sell your house". Our latest GV is $380,000. But my husband and two girls still at home are totally distraught at the thought of losing the house on top of everything else.

I have managed to get a low-paid job and gross $1800 per month. We can pay the bills - just - and food, but nothing else.

My husband will probably never work again. The girls take care of themselves financially so they are no burden and are a real comfort to me. We would hate to sell up. I've looked, but there's really nothing like this old family home we've lived in for 20 years.

Please help. I'm getting desperate but not losing hope. We thought we would work untilwe were 60 and by that time we'd have had 10 years of saving, but that was not to be.

Life insurance is only $10,000 and there's nothing else but a 10-year-old car. Luckily no debts at all, and no hire purchase.

A. Firstly, good on you for being mortgage-free and debt-free. So many households aren't, and it certainly makes a difference when tough times strike - as they surely have for you.

If you still owed money on your house I would be joining the chorus suggesting you move to a smaller one.

But, under your circumstances, I think you should stay put - at least for the next few years. Your family has been buffetted enough without losing your home base as well.

How, then, do you boost your financial situation? Basically, there are three ways: Cut your expenses, raise your income, or manage your money better.

You have probably already looked hard at how you spend your money.

If not, try drawing up a list of what you think you spend monthly, and then compare it with your actual spending. That can lead to some insights on what you could do without.

Don't eliminate all treats, though.

Raising your income? Presumably you've got an eye out for a better-paying job.

Also, talk with your family about what you do well: Flower-arranging? Child minding? Interior design? Gardening? Baking?

Perhaps you could supplement your income by doing this in your community. People are increasingly keen to pay others to do all sorts of things for them.

And don't undercharge. Many women do.

Do your daughters pay board? It's perfectly reasonable to expect that. And could you take in a boarder or two? There's not much more work cooking for six than four.

Your main money management question is what to do with your $18,000.

Despite your reluctance, I think you should consider a longer term deposit for two reasons: the higher interest, and the fact that it makes it harder to eat into. You really want to maintain your savings if possible.

Your situation is in some ways similar to the previous letter writer's. Weigh up the likelihood of having to break a two or three-year term deposit, and the penalty if you do, against the advantages.

I hesitate to say this, but you might even find that, in a medical emergency, you wouldn't have to pay the full penalty. Officially this isn't so. But I have heard of cases in which bank managers have quietly shown they have hearts.

Whatever you do, don't count on it. But if the situation does arise, it wouldn't hurt to inquire.

Meanwhile, keep up the positive thinking. Longer term, things might well ease up. It's certainly your turn for a little luck.

Your husband might be able to at least do part-time work - perhaps by looking into whatever he does well.

And once you're more settled and your daughters have left home, you might consider moving to a smaller house.

Q. Do you have any comments on Brent Sheather's article "Nest-eggs look fragile" in last week's Weekend Money?

He suggests that a balanced portfolio long term could reasonably be expected to return 7.2 per cent a year pre-tax and pre-fee.

But after management fees, monitoring fees and tax are deducted, a net return of about 3 per cent could reasonably be expected.

If these figures are accurate, there seems little point in taking on any equity risk, as a bank term deposit could produce the same result.

A. Sheather's figures look pretty good to me. But, while your conclusion seems logical, I don't agree with it.

It's fair to say that there's little point in investing in a balanced fund, such as the one Sheather writes about, with 50 per cent in shares, 40 per cent in bonds, and 10 per cent in property.

The various fees are so high that, as you say, you could do as well in a term deposit.

This is particularly true if you enter the fund via an adviser and pay her or him a monitoring fee.

The situation is different, though, if you invest in a share index fund, without using an adviser.

You would pay no monitoring fee, the fund would pay no tax on capital gains (index funds are exempt), and the annual management fee would be considerably lower (there's little work in running an index fund).

Also, the returns on a share fund are higher than on a balanced fund, because it's riskier. Sheather comes up with an 8.2 per cent expected return on shares, pre-tax and pre-fees, and that sounds about right.

Starting at that higher point, and with lower fees and taxes, a share index fund is likely to outdo a term deposit.

Another point: by historical standards, term deposit returns are unusually high at the moment, relative to inflation.

Over the long haul, the gap between returns on shares and on term deposits is likely to be bigger than it is currently.

Of course, many people would find it too risky to invest in a fund that holds only shares - which is why balanced portfolios are popular.

But there's nothing to stop you doing your own balancing. You could put part of your savings in a share index fund and part in term deposits.

What about property? Many people have more than enough in property anyway, because of home ownership. But if you wanted more exposure you could invest in an index fund that specialises in property shares.

* Got a question about money? Send it to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@journalist.com. Letters should not exceed 200 words. We won't publish your name, but please provide it and a phone number in case we need more information.