In this series of money discussions, we share real money questions people have for personal finance expert and Founder of MoneyWhizz, Mr.Frank Conway.
John – Kildare asks:
Hi Frank. I attended one of your recent seminars hosted by my employer and we chatted briefly. Anyway, I mentioned that I have €160,000 in savings on deposit at two different banks and with my salary, I can save more. I am 43 years old, married and pay 3% of my salary into a pension; my employer matches another 3%. I have a tracker mortgage which costs me .95% but I am thinking of paying it off quickly, is this the best use of my money?
You are in a good place financially. However, without knowing your overall situation, based on the information you shared, I think a few obvious points stand out.
First, you are leaving money on the table when it comes to your pension. While you may be maxing out on the match of the employer’s contribution, you are not taking full advantage of the total tax efficiency being given to you by the State. And the fact you appear to have a high degree of net income which you are using to grow money on deposit, this is in fact a waste of money for a number of reasons. Primarily, you earn next to nothing on deposit but you are liable for DIRT tax of (37% – 35%) on any interest income presently. Additionally, you could be using your allowable tax relief to grow your pension pot tax efficiently by setting up and additional voluntary (AVC) contribution in parallel to your existing pension arrangement. With the AVC, not only will you maximise your tax efficient contributions, any investment growth realised through the AVC is tax-free, unlike interest earned on deposit. At age 43, you can put aside 25% of gross earnings up to a maximum income of €115,000 per year so you should seriously consider this as a smart way to grow your financial security for your post-employment years.
On the matter of that money you have on deposit, while it can be tempting to be conservative with money you have worked really hard to earn and save, just keep in mind you still need to limit the destructive impact of inflation on that money. At a minimum, even if you can muster a rate of .2% – .5% on your deposits, inflation destroys the value of money. Inflation is under control at the moment but the target rate of inflation is around 2%. In the coming years, with a growing economy, the risk of inflation will also grow. This means the net impact on your money on deposit could be minus 1.5% (2% – .5% deposit rate). So, on a yearly basis, that safe place your money is held on deposit is actually losing buying power. In fact, simply leaving the €160,000 on deposit earning say .5% with inflation at 2% means you actually lose €2,400 per year. This is why you need to consider taking on limited risk and investing some of that money just to counter the impact of inflation on the balance.
When it comes to investing, I suspect you may want to be conservative so your best bet is to consider a mix of index fund options. Perhaps ones with a higher focus on bonds but don’t be shy of equities also as a good money manager should be able to offer you a highly competitive total cost of management. And when it comes to investment fees, this is where you really need to do your homework. Look for a money manager that offers the best TER / OCF (Total Expense Ratio / Ongoing Charges Figure – this is like the APR of investing). There are some investment managers in Ireland that are very progressive in this space with a mix of global fund options. Remember, your goal here is to beat inflation so you need to be getting annual growth rates of 3% – 4%. Also, the better managers may offer you the option of paying an up-front fee for their services and where they do, you should be in a better position to avail of a very low OCF. Be prepared to question any investment manager that offers their services at no cost to you. Great investment advice is extremely valuable so if it costs you nothing to invest, ask how this is possible. Usually, no up-front fees are funded by back-end trail commissions that you end up paying for anyway but which are taken from the overall value of your fund and the ongoing fund growth and this really limits overall performance. Keep in mind that when it comes to investments, what you can’t see CAN kill…in this case; performance.
Finally, on the matter of your mortgage and other big expense items, keep in mind that interest rates are likely to increase over the coming years. When they do, this means your tracker mortgage repayment will increase too. With a lot of money on deposit already, you should be more than covered to meet the rising repayments and I expect your net income should more than cover the extra costs anyway. But as a rule of thumb, 3-months cash in that rainy-day account is a reasonable amount to plan for always.
Frank Conway is a Qualified Financial Adviser and Founder of MoneyWhizz.org, the financial literacy initiative. He works with leading employers on a range of financial well-being campaigns and is author of Ireland’s Essential Guide to Personal Finance.