By Mary Holm
Q. We are a couple in our mid 50s and have $40,000 to invest for 10 years in one of the two following ways:
* Invest the total amount in a diversified international share index fund e.g. Tortis, WiNZ.
* Purchase a $90,000 residential property in Christchurch with a $50,000 10-year first mortgage. This would be tenanted by our son and his family who would maintain and improve the property on a shared capital gains basis if/when it was sold.
The rent payable by them would fully cover the rates and repayment of interest and principal. The property would be mortgage-free after 10 years.
Which option do you recommend?
A. This is an interesting variation on an old debate: rental property versus share funds. It is also an example of some good creative thinking within a family.
By knowing your tenants, and by giving them an incentive to take good care of the property, you seem to have tipped the scales in favour of rental property. But have you?
Looking at the income situation, you would keep the dividends from the share fund whereas you would spend all your rental income on the mortgage and rates. And don't forget insurance.
Still, the dividends will not make much difference. Dividends on international share funds tend to be pretty small and largely eaten up by fees and taxes.
Of more significance are capital gains. If you go with the property option you will benefit from gearing, (provided the value does not fall over the time you own it - which seems unlikely).
If, for example, the property value rose 10 per cent from $90,000, you would make $9000. If you invested in the share fund and it rose 10 per cent, you would make only $4000.
It won't quite work like that, though, if your son's family is sharing in the capital gains on the property.
If you make a 50:50 deal, you would end up with a $4500 gain, which is pretty close to what you would get in the share fund. You largely undo the effect of the gearing.
Note, too, that I assumed in our example that the values of the property and share fund would grow at the same 10 per cent pace.
Nobody knows but I would expect the share fund, with reinvested dividends, to grow faster, especially over 10 years or more.
(Shares tend to bring higher returns than property. This is largely because they are riskier. But you have reduced the risk by going into a diversified fund.)
So where are we? Perhaps the share fund now has the edge. It is so close, though, that it makes sense to let family issues sway you.
The rental arrangement might suit your son well. Not many tenants get the chance to share in capital gains.
But 10 years is a long time. What if, a few years down the track, your son or his wife gets a great job offer in another city? Or they want to go overseas? Or they find a better property elsewhere for lower rent? Or you don't think they are maintaining the property well enough?
You could always switch into a share fund at that point. But then you would pay both share fund entry fees and real estate buying and selling costs. And you might have to sell the property in a hurry, in a weak market. Better to stick with one option.
Talk through these scenarios frankly with your son's family. Then decide.
Q. You have often mentioned that property is not necessarily the best long-term investment. I would appreciate guidance in the following scenario.
I have eight years to run on the mortgage for my house - valued at $230,000 with equity in the property $160,000.
I wish to work overseas for five years. I can rent out the house, with a market rent able to cover mortgage, rates and insurance payments.
When I return, I move back into my home and three years later I am mortgage-free.
I have heard horror stories about tenants. If I sold up before going overseas how could I invest the proceeds of the house sale, then be able to move into a similar property on my return - with the aim of being mortgage-free after a further three years?
A. Your best bet is a share fund. I like index funds and suggest you put at least half your money in an international index fund.
This puts us back to the same rental versus share funds issue as in the last question - but with yet another twist.
If you rent out your house you will benefit by the capital gain on it over the five years, plus repayments on the mortgage principal. Call that total $X.
If you sell the house now and put the $160,000 in a share fund for five years, you will want it to grow by more than $X.
You will also want to cover the costs of selling the house, getting into and out of the share fund, and buying another house on your return.
That is quite a tall order. Will the share fund meet it? Once again, we are in "nobody knows" territory.
The fact is that both of your options are quite risky.
The biggest risk in the share fund is that its value could fall, although that is highly unlikely over five years. But there is a fair chance it won't grow as much as you hope.
One risk in renting out the house is that your mortgage interest, maintenance, insurance and rates might rise above your rental income.
Don't forget to allow for periods when you have no tenants. And note that - unlike most landlords - you won't be able to deduct the mortgage interest on your tax return because when you originally borrowed the money it was not for investment purposes.
You will also have to pay a property manager. And there is a good chance they won't run the place as well as you would.
As you say, there are plenty of tenant horror stories. And they are often worse when the landlord is on the other side of the world.
It is no fun to get a phone call from home asking for money for major repairs. Nor is it uplifting to return to find that a previous tenant painted everything lime green, and nobody has cleaned anything since.
Okay, a friend told me off for being too negative about tenants. Most are decent. If you were going away for a year, I would say, "Pick good tenants before you leave and you should be fine."
But five years? The share fund might be more lucrative and - provided you don't freak out every time its value drops for a while - a lot less of a worry.
Q. On September 5, 1997, I purchased $25,000 of 10 per cent Tranz Rail bonds for $27,112. On October 15 this year they matured, giving me a repayment of $25,000 and creating a loss of $2,112.
Can you please advise whether this loss can be offset against other income for tax purposes?
I am not a dealer in stocks and shares for tax purposes and do not pay capital gains tax. But I hope that despite this the loss will be allowable as a deduction from my other income.
A. You are in luck. On your tax return, you will win from your loss.
Bonds are "financial arrangements" rather than equity investments, says an Inland Revenue expert.
If you make a gain on a bond - you get more at maturity than your purchase price - that is taxable. If you make a loss, it is deductible from your other income.
These rules apply regardless of the amount of the bond, or your reason for buying it.
And they make a lot of sense. You knew when you bought the bond that you would make a loss. Presumably you were willing to do that because, in the meantime, you were receiving interest at higher-than-market rates. (When the bonds were first issued, some time earlier, interest rates were higher.)
You had to pay tax on your interest income. So it is fair that you can then deduct the loss which, in a sense, balances out that extra-high interest.
In the reverse situation, if you knew you were going to make a gain at maturity you would accept lower-than-market interest in the meantime.
That means you would pay less tax on your interest than if you had invested elsewhere at market rates. So it is then fair that you pay tax on the gain, which balances out the low interest.
There is something comforting about a tax rule that is logical.
Q. I agree with you that annuities can be satisfactory investments. They can, though, be difficult things to obtain hard facts about.
Five years ago I wondered if it would be practical to buy an annuity with about half of our savings on retirement.
It was recommended that I ring AMP or Tower. The telephonist at AMP was quite sure that her company did not have any investment of that nature and reluctantly transferred me to someone in the investment department. That person had at least heard of an annuity and promised that someone would call me back. No one ever did.
At Tower, I was put through to someone who said brightly that they did have annuity schemes and would send someone to my home to discuss the matter.
The chap was a friendly fellow who told me that he had spent most of his life as a taxi driver and had worked for Tower for just a few months.
He asked whether I was interested in life insurance or managed funds. I explained that I wanted to find out about an annuity. He was sorry but he did not know anything about them. He would be happy to ask in his office if I would like someone else to call at another time.
At that point I went off the idea on the basis that if annuities were not easily available or accessible then perhaps they were not the straightforward investment I had imagined them to be.
Things may well have changed since I made my inquiries. I do hope that those now seeking details of annuities have more success than I did.
A. They do - at least going by two people's experience. But things could still be better.
One of the two is a reader who wrote to thank me for introducing him to annuities via this column.
He asked the five annuity providers for quotes.
"Royal & SunAlliance and Fidelity answered promptly, but the other three, after 10 days or so, had to be approached again," he says.
In the end, though, he got quotes from all five.
"To spread the unlikely risk of insolvency, we decided to split $100,000 each between Tower and Royal & SunAlliance," he reports.
The other person was myself, making inquiries under another name.
I rang each company and said I was interested in getting an annuity when I retired, in about 10 years, and wanted general information about them in the meantime.
In every case I eventually found someone who knew what annuities were - although sometimes I was passed around several people first. And I had to leave two messages with Colonial before I got a response.
At Fidelity Life the man said they did not send out written material, as they sold so few annuities. But he did talk to me at some length and what he said was sound advice.
The other four said they would send me investment statements. Colonial, Royal & SunAlliance and Tower did so promptly and their statements were pretty readable. AMP's investment statement never arrived.
It is probably not fair, though, to draw sweeping conclusions from so small a sample.
The main message seems to be: You can get information on annuities but you might have to persevere a bit.
An easier way is to ask an insurance broker to get quotes for you. But make sure all five providers are included.
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By Mary Holm