For several years now, the European Central Bank has been driving down the cost of money. This is good news if you have a mortgage, especially a tracker mortgage or a standard variable rate mortgage. But it is not very good if you have a lot of cash on deposit.
So, with rates as low as they are, what might be some other ways depositors can put their money to use.
Here at St. Joseph’s Irish Airports & Aviation Credit Union, we have a few ideas:
1. Pay off high-interest debt – especially if you have credit card debt. Since credit cards charge interest that ‘compounds’ each and every month, this means that your debit will take far longer to repay…and cost a lot more!
2. Pay extra off your mortgage – in case you did not know it, the longer the term on your mortgage, the more interest you will pay. So, regardless of whether you have a tracker or standard variable rate mortgage, when interest rates eventually rise, this will make your mortgage more expensive so if you have the cash, it might be a good idea to pay off a lump-sum amount or pay off a little extra each month. Check with your mortgage provider if they will even accept payments bi-weekly. Also, fixed rate mortgages usually incur pre-payment penalties so check carefully if mortgage lenders offer any pre-payment facilities for fixed-rate mortgages.
3. Consider those tax-free gifts – The first €3,000 of the total value of all gifts received from one person in any calendar year is exempt. For further information, check out www.revenue.ie or www.citizensinformation.ie.
4. Invest in your home – home prices are rising rapidly across many areas in Ireland so keeping your home in tip-top shape is a good way of protecting your most valuable source of personal wealth…and there are tax benefits too under the Home Renovation Incentive (HRI).
5. Enjoy life – and have a little fun!
There is little doubt that Ireland is experiencing a chronic shortage of family homes. And this shortage is fuelling a dramatic rise in property prices.
Some commentators are comparing today’s property price rises to those of a decade ago when property prices in Ireland peaked.
But the property market in Ireland today is a completely different.
For starters, the sheer scale of property completions and mortgage draw-downs in 2007 dwarf today’s by scale of at least 5 – 6 times.
In 2006 alone, over 110,000 mortgages were drawn-down by first-time buyers, second-time buyers and buy-to-let investors. Today, the figure is closer to 28,000. And when it comes to property completions, today, there are just a handful of completions compared to 70,000 or more 10 years ago.
Small-time investors have largely disappeared, scarce credit, tough tax rules and tougher rental controls have scared all but the most seasoned and well-financed from what once was a ‘sure bet’ investment of choice for tens of thousands of people across Ireland.
Opportunity to look at different investment options
So, while property may lose a lot of its allure for many prospective investors, new opportunities are presenting a growing opportunity for growing personal wealth.
If we look at how and where money can grow, the stock market is still a really good example of growth options over the long-term.
Stock market is a great diversification channel
Using the MSCI World Index, in the period 1970 – 2015, it grew on average by 7.8% per year. Some years were better than others but it is the overall rate of growth that one needs to consider if they are really looking for ways to grow their personal wealth.
This means that for every €1,000 invested in 1970, it would be worth about €34,000 today. But, what is particularly interesting in the calculation is that while the €1,000 invested generated €3,666 in simple interest, it was the compounding interest of €29,460 that really created the wealth. The calculation is based on a tax-free pension investment and serves as a fair comparison to a family home where no capital gains tax applies.
But let’s say we consider the €1,000 investment over a shorter period of time, what is the return-on-investment then? The answer is still impressive. The €1,000 invested grows to €13,857, of which €2,730 is simple interest earned and €10,127 is compound interest earned. A 35-year comparison is a more realistic time period to examine as it reflects the time to retirement for someone investing is a workplace pension arrangement.
Interestingly, in reality, the MSCI index, in the 35-year period to 2015 grew by 9.4% so the €1,000 invested should be worth €23,207 today.
A major consideration in any investment today, in addition to the expected investment period and growth rate are fees and it is the fees, when minimised can have a major impact.
Put another way, fees reduce the rate of return massively.
Let’s say we take the €1,000 invested in 1980 / 1981 and the rate of return was 9.4% but the fees charged by various investment managers cost about 3.5%. This would reduce the effective annual rate of return to 5.9%. The €1,000 in 1981 would be worth about €7,436. But, if the management fees could be reduced from 3.5% to 2%, the final investment would increase to €12,166, an increase of 63% by just securing a lower management cost.
No escaping fees but minimising them is possible and critical
Management fees are an integral part of the investment landscape. Managers and advisers need to be paid to turn up and management your money. This takes expertise, compliance procedures, security procedures and paper trails. But, within the financial investment landscape, there is a raging debate about two very different approaches.
Passive Vs Active
On one hand of the investment debate are investment gurus such as Warren Buffett who argue that index funds are superior when it comes to generating higher return-on-investment opportunities. He supports the investment philosophy of companies such as US based Vanguard which has been a pioneer in low cost, passive or index investing. They argue that so-called active investors simply cannot generate a higher rate of return than passive, or index –based investing over the long term and recent long-term evidence supports their claims.
For Irish investors, it is the low-cost investing route that presents the highest possible rate of compounding growth over the long term. In other words, this is where the money is when it comes to generating return-on-investment.
So while property may continue to have a very powerful pull on the Irish investment psyche, there are other ways of growing personal wealth. The stock market is a powerful way of doing so. Investing passively where management / investment fees are kept to minimum and through pension structures, where long-term growth is tax-free is the surest bet to creating a high rate of personal wealth growth.
By Frank Conway
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” – Albert Einstein
OK, just be warned, despite the quotation from Mr. Einstein, this is NOT going to be a complex maths lesson, it is going to be a simple money lesson.
But first, what exactly is compound interest? Well, put simply, it is interest-paid-on-interest and it can really can work wonders for you!
Compound interest has very positive and negative consequences but for now, let’s focus on the positives of how it can work wonders for your personal finances.
Einstein’s Rule of 72 shows how long it will take to double your money, based on an anticipated interest rate. It’s really easy to figure out and super-important to understand. If you were to earn a 4% return on your money, it would take 18 years to double your money (72/4=18). If you can earn a higher rate of return on your money, the time to double your money shortens proportionately.
“So what” you might ask. Where the rule of 72 comes into play for you? Well, that’s easy.
Time and your ability to earn income are incredibly powerful. Let’s say you’re a college student and you invest €10 a week while in college and earn a 6% rate of return that compounds annually. At the end of 4 years, you’d have €2,158! But let’s say you decide to continue investing just €10 a week for the rest of your life until you retire at age 68 (that’s a total of 49 years, assuming you start at age 19, would have turned into €134,603. To put this in perspective, you actually saved €23,501 but the power of 6% interest compounding each and every year meant that your savings grew exponentially over time. And all for just €10 per week!
So spare a thought for Mr. Einstein and his Eighth Wonder of the World, it can really work wonders for you!