Subsidised super schemes hard to beat

Q. I'm a 42-year-old single parent, about to re-enter the fulltime paid workforce.

My salary and child support will come to around $60,000 gross. I don't expect a significant increase in my income in the next few years.

I own a home in an appreciating area of Auckland. It is worth about $400,000. My total debt, all mortgage, is about $210,000.

I've paid off credit cards, store cards, student loan and car during the past few years.

My new employer runs a subsidised superannuation scheme. Given my age and my commitments, am I better to invest a little in the super scheme or to focus on reducing my debt levels?

A. Repaying high-interest debt is pretty much always the best use of your money. But you've already done that. Generally speaking, repaying a mortgage comes next. Getting rid of a debt on which you are paying, say, 8 per cent interest improves your financial situation in the same way as owning an investment with a return of 8 per cent, after tax. Stopping money going out is as good as putting new money in.

Any investment that pays more than mortgage interest, regardless of the level of interest rates and returns at the time, will always be risky. You would have to invest in shares, property or higher-risk debentures, all of which might bring in more than 8 per cent, but they might not.

Repaying your mortgage is about as low risk as you can get.

There is, however, a counter argument. It's best to put most of your spare money into repaying your mortgage, but consider putting, say, $100 a month into a well diversified, low-fee share fund. There's a reasonable chance that, over years, the average return on the share fund will be higher than 8 per cent after tax.

Also, it gets you into another type of asset, so you're not concentrating only on housing. There's nothing like being invested in the sharemarket for learning how it works - it goes up and down but always trends upwards over the long haul.

Once you've paid off your mortgage, you will then be ready to put more of your savings into the share fund.

Which is better: All mortgage repayments or a bit of share fund on the side? Whichever feels more comfortable. In your case, however, there's a complication. You have the option of investing in a subsidised super scheme. And the subsidy makes all the difference.

Let's say you have a choice of:

* Repaying an extra $200 a month off your 8 per cent mortgage, for 10 years. That would improve your wealth by about $36,000.

* Investing $200 a month into the super scheme, which your employer matches dollar for dollar, bringing the total to $400 a month for 10 years.

Even if the return on the scheme was zero, that would improve your wealth by $48,000. And you can be certain you'll do better than that over a decade.

What if the employer gives you 50c for every dollar you invest? Your $200 a month would then grow to $300.

That would still come to $36,000, after 10 years, if the return was zero, and $46,300 if the return happened to be 5 per cent a year.

The results will be the same, comparatively, whether you put in just $50 a month or $5000 a month.

To work through other examples, use the regular saving calculator on the Retirement Commission's www.sorted.org.nz

Of course, mortgage rates and investment returns will change over the years. But they will stay much the same relative to one another.

It's hard to imagine a scenario in which a super scheme with at least a 50c-in-the-dollar subsidy doesn't beat repaying a mortgage.

A final note: In the calculations, I have ignored inflation to keep things simple.

In this situation that doesn't matter much, as it's the comparisons rather than the absolute numbers that are important.

However, when you use the Sorted calculators, they suggest you use returns after inflation. Then, when you get a savings total of, say, $20,000, that means you will have savings that will buy whatever $20,000 buys today.

In the above examples we might use 5.5 per cent instead of 8 per cent for the real (inflation-adjusted) rate of interest on the mortgage.

That shows us that repaying the mortgage would improve your wealth by $31,700 in today's dollars. And we might use 2.5 per cent instead of 5 per cent for possible growth on $300 a month for 10 years.

That would bring us to $40,800 in today's dollars - still well ahead of repaying the mortgage.