We have $200K sitting in an investment loan offset account, should we keep it there, invest in shares or add to super? We would like to retire in 15 years.
– Question from Lyna in Kellyville, NSW
What a great question! Before we jump in, I must warn you that this information is of general nature only as I know too little about you and your circumstances. You would probably benefit from seeing a financial planner for advice that would be tailored to your specific situation.
In general, there are several issues that would need to be considered here. I have listed a few of those below.
1. Tax efficiency
I don’t know anything about your household cash flow but I can be fairly confident in saying that most people don’t like paying too much income tax. You mentioned that your savings are offsetting your investment loan – this means you are not paying as much interest on your investment loan as you normally would. However, it also means that you are unable to claim any tax deductions with regard to this interest. Assuming that your investment loan is a deductible loan (secured by an asset that generates an income), you may be able to use it more efficiently to reduce your income tax.
If, however, there isn’t much tax to consider and you do not need the deduction, then, of course, having the funds offsetting the interest is a valid strategy to reduce your expenses.
Further to this, you may wish to consider where your cash/investment is held as you will pay different tax rates on the income earned in various structures. For example, when investing in your own name your investment income will be taxed at your marginal tax rate (i.e. 37%), when you invest in superannuation, your income tax inside super is generally 15%, if you invest in an investment bond structure, you may limit your tax to 30%, and if you have an allocated pension account (i.e. when you retire), you likely pay no tax on any investment income at all.
2. Expected Rate of Return
It is the return conversation that sparks much of the super-vs-loan dilemma these days. Given we have a very low interest rate environment and the debt is cheap, there is a high likelihood you would be earning more in the share market. For example, if your loan interest rate is 2% p.a., then your offset account is “earning” you a guaranteed 2% return. However, if your last superannuation statement quotes an average return of 10% p.a. over the past 10-15 years, you are probably feeling that you are missing out. In the first scenario (leaving your money in the offset account) you will have saved yourself about $69,904 in compounded interest repayments by the time you retire in 2036; whereas in the second scenario, you will have grown your $200,000 to a balance of $890,784 over the same period of time (Look up Compound interest calculator on Moneysmart website).
The issue here is that we don’t know what interest rates will look like tomorrow and what the share market will do. We can only rely on the information in front of us and the historic data. This means you must assume a degree of risk whichever decision you make. You could leave your money in the offset account and “miss out” on returns in super as in the above example OR you could invest in superannuation only to see the market crash and the interest rates rise. This brings us to the next important point…
3. Your Risk Tolerance
The return you can hope for largely depends on the level of risk you are prepared to take. Growth assets like shares and property historically earn a higher rate of return than defensive assets such as cash and bonds (just look at the last 30 years of returns for various asset classes provided by Vanguard). The trouble is no one knows what is going to happen tomorrow so it is important to ensure that you are not going to lose sleep over what you are invested into. To your question whether you should be buying shares, my honest answer is “I don’t know”. It depends on whether you would be able to withstand the constant rollercoaster that is the share market and whether you would be able to resist getting off it at the wrong time (i.e. when the market drops).
If you are terrified of the unknown, you may be more comfortable earning 2% instead of 10% but knowing your money is in your bank account.
4. Liquidity and accessibility
Liquidity refers to the ease with which you can access your money as cash. Cash is, therefore, the most liquid of assets while tangible items like property are less liquid (you can’t sell a bathroom in the investment property to free up some cash). Shares are less liquid than cash as they require a couple of days to be sold and managed funds may take longer. In the worst-case scenario, some of the investments may become illiquid for a time (i.e. many managed funds were frozen during the Global Financial Crisis). With superannuation, you also have an issue of accessibility due to preservation rules. For example, if you contributed your $200,000 into superannuation but you won’t retire until age 65, you will not be able to access the funds until your retirement. Even if you decided to retire earlier, say, when you are 58 years old, if you were born after 1 July 1964, the earliest opportunity you would get to withdraw your super would be age 60. This means there is no change-of-mind policy in place, where you could put your funds in super and then take it out.
The positive side of accessibility is that once it’s out of sight, it’s out of mind and this may help preserve your money long-term.
5. Term of Investment
Finally, Lyna, you should also consider how long you are going to invest for. If you are retiring in 15 years, are you able to set these funds aside for that period without touching this money? If the answer is yes, you are in a good position to start your long-term journey and should have more confidence when investing based on the previously discussed historic returns. However, if you are unsure and think you might need the cash for any other purpose short term, you may have to choose your priorities. Personally, I consider any investment under a 5-year timeframe a short-term investment and caution investors about higher risks of negative returns during this term. If they are happy to “stick it out no matter what” and have the time, then it’s all systems go and the share market is a good place to be. I’ll leave you with one of Warren Buffet’s famous quotes – “I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”
Lisa Scott is a Financial Planner at Blue Harbour Financial Partners and an authorised representative of Fortnum Advice Pty Ltd ABN 52 634 060 709 AFSL 519190
This is general advice only and does not take into account your objectives, financial situation or needs, so you should consider whether the advice is relevant to your personal circumstances. You should also read the relevant Product Disclosure Statements (PDS) before making any financial decisions.