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Reduce Debt Or Save


Is it better to save, or pay off debt? In most instances, particularly during times of low inflation, the answer is almost universally that it is beneficial to pay off debt before saving. This is the line of thinking promulgated by the Retirement Commissioner and, until recently, by the Shape of Money.

However, after working with clients at the financial planning coalface, we have changed our view. We recommend that clients begin saving a small, regular amount into an overseas share investment. We suggest a monthly contribution of $100.

There are several reasons for this recommendation.

1) It builds a savings habit.

2) You gain satisfaction as the small investment starts to build into a longer-term nest egg.

Is your home your only retirement asset?

3) New Zealanders have an awful habit of increasing their mortgage once it has been repaid, to add a room or renovate, for instance.

House renovations etc are personal and emotional decisions that only you can make. the Shape of Money's role is to suggest that, by increasing our mortgages, we are living beyond our means. Not today, perhaps, while we earn a nice income, but certainly when we are in a retirement which hopefully will last 20 to 30 years. New Zealanders as a group tend to retire with little to their name but a large, mortgage-free home. This raises several issues:

  • New Zealanders like living in their house and in their particular area, and they don't necessarily want to trade down,
  • and
  • Even if they do want to trade down, there is the risk that there may be many other people in a similar position trying to sell 4 bedroom homes in suburbia to a market which really wants 2 bedroom inner-city apartments.

Gaining an exposure to the share market

4) It is also important that you gain exposure to the inevitable swings and roundabouts of investing in shares and the associated currency movements.

Part of the investment planning research we undertake enables us to understand the risk profile of each client. There are a number of facets to this, but you may be familiar with the "risk profile quiz". For example: "How familiar are you with the investment markets? 10 points for no knowledge, 20 points if you are comfortable with the markets", etc.

What we find is that most clients fall into the defensive/conservative category, yet many clients should ideally be more balanced investors. However, for various reasons, they have an aversion to the share market.

The difference between being a defensive and a balanced investor could be as much as a 2% real return after tax and fees. On an investment portfolio of $250,000, the defensive client is missing out on a potential return of $5,000 each year, or $100,000 over their 20 year retirement.

Our recommendation

Our recommendation is that you get an early and regular exposure to the share market. It's a long-term view of your financial life, but it is a discussion we have with most of our clients who have mortgages. Note that this approach does not guarantee an instant love affair with the share market, but it is an immunisation shot to help you weather the investment storms, and it may add thousands to your retirement nest egg.

Some final general thoughts

  • All "bad" consumer debt, such as credit cards, should be repaid before considering any saving or investing options.
  • In broad terms, you need to understand that the income you are going to earn between now and when you retire will need to last you not only through your working years, but also long into your retirement years.
  • Seek the advice of a competent financial adviser. You need advice to match your personal situation and goals.