Q – My partner and I are saving for our first home and have finally reached $50,000. Should we invest in shares whilst we save?
Kyle’s Answer:
Firstly, congratulations on your great progress so far! It’s not easy to save that amount of money, particularly if you’re living in a capital city.
You’ve probably heard it before but investing in the share market is a long-term game. My general rule of thumb is if you need the money that you’re investing in the next seven years, you shouldn’t risk it by investing in the share market.
Investing in the share market has and will continue to provide good investment returns over the long-term, however, like gravity, the risk vs return equation will always hold true. This means that the share market will continually move up and down and over shorter time periods the chances of experiencing a loss are greater.
So why seven years? No one can predict the future so there’s no exact number however many funds will recommend a minimum investment timeframe of 7 years. Historically, this is a maximum timeframe it would take to recover your money if you were to invest when the market was at its peak e.g. in late 2007 the Australian share market peaked and it didn’t reach similar levels (including reinvested dividends) until the end of 2013.
Let’s say you invest $50,000 today and it just happens to be the peak (there’s no way to predict when there is a peak) and you want to buy a home in three year’s time after you’ve factored in how much you and your partner can continue to save. Disregarding the additional savings, when you need your deposit in three year’s time it’s possible your $50,000 is now only $40,000 or worse. On the other side, it could be $60,000 or better but no one can accurately forecast this. There are enough things to worry about when buying a home, tuning into the nightly news worrying where the share market is at shouldn’t be one of them.
So what’s the alternative? I find the best option is often to look for a High-Interest Savings Account and continue to concentrate on your savings to keep your momentum going.
Q: A friend has told me to look into an investment bond to save for my 2 year old’s future education costs. Are these worthwhile?
Kyle’s Answer:
It’s great you’re looking ahead and if you can afford it, you absolutely should save and invest for a large future expense like children’s education.
There are two main reasons why people invest in investment bonds: convenience and tax benefits.
Convenience
Investment bonds are convenient. They’re relatively easy to set-up and it’s easy to automate regular savings to be invested. This automation is great as I find it leads to a higher chance of you sticking to your plan. It’s like meal prepping on a Sunday night so you eat healthier and cheaper throughout the week.
Tax benefits
Investment bonds are a confusing product to the point that they’re misunderstood by many financial experts. Although they do have their tax benefits, they’re not as tax effective as many experts (and providers) lead on.
The common advice is “invest in an investment bond if your marginal tax rate is above 30% as the investment bond only pays tax at 30% and there’s no tax liability to you personally after 10 years”.
This is true and as anyone who earns more than $37,000 has a marginal tax rate of more than 30%, many people are attracted to them.
When you invest in growth assets like shares, often a lot of the return comes from capital gains and these capital gains are taxed at half of your marginal tax rate (if held for more than 12 months) when held in your personal name.
Investment bonds don’t get this benefit and contrary to what many believe, they’re taxed on all income, including gains at 30%.
For this reason, I rarely see tax advantages when investing in an investment bond in growth assets unless the only alternative is to invest in the top marginal tax rate (47%) when income is greater than $180,000. As it’s rare for two members of a couple to have incomes of $180,000+, they’re rarely appropriate to be used to save tax.
Although they are convenient, this convenience isn’t exclusive to investment bonds so there are likely cheaper alternatives if your tax position is such that an investment bond would disadvantage you.
Kyle Frost is an independent financial adviser at Millennial Independent Advice where he helps people in their 20’s and 30’s make smart decisions with their money. Click here to subscribe to his updates.