Getting the Porsche
Most of you will have watched those initial TV ads for the NZ Lotteries Commission’s new Big Wednesday lottery by now: he says he’d like a Porsche, she says she’d like a Range Rover. They decide they’d like both. Winning lotteries is one way of achieving personal wealth but the reality is the majority of us won’t achieve the lifestyle we dream about without setting some pretty stringent financial goals.

Unlimited approached four top financial planners and investment advisors to provide some basic advice to two families (their names have been changed for privacy reasons) who have just received a $100,000 inheritance from their grandmother (this bit is made up).

The aim is to give readers some idea of where to start with their own financial goals.
In real life, though, all four experts say they’d ask for more information on your personal circumstances and aims than that provided in these two examples before providing advice. Paying off the mortgage as a first step was the strong theme in the advice from the four experts, and the amount we’re all going to need to generate to maintain our existing lifestyles on retirement is truly scary.

Couple One
Bruce, 40, and Judy, 38, are an Auckland couple with a young baby. Their income is currently reduced to around $50,000 a year. Bruce is a self-employed software programmer who for the past three years has been developing his own software product, which is now being rolled out. His wife, Judy, is a freelance journalist who is working only a few hours a week while looking after their baby.
Their property assets — a North Shore house, a Coromandel bach and a Kawhia section (currently for sale) — are worth around $1.3 million. They have a fixed mortgage of $150,000 and a floating one of $90,000.
Objectives: They want to lower their mortgage, do extensive house renovations and put some money aside for their child’s education and for retirement.

Couple two
Auckland partners John, 45, and Maria, 43, have two dependent teenagers. Both sales employees, they have a joint income of around $215,000 a year. Their property assets — an Auckland home and north Auckland bach — and other investments total just over $1.52 million. They have a $180,000 mortgage on one home and an $80,000 one on another.
Objectives: To both be able to retire in five years. They are comfortable with medium- to high-risk investments to try to achieve this.

Frank Pearson
Pearson Investment Advisory
Frank Pearson began his life in the industry as an investment analyst in London in 1970. Later emigrating to New Zealand, he spent 15 years in investment management for three local institutions before setting up Pearson Investment Advisory, providing strategic investment advice to individuals, families (trusts) and tax exempt funds. He’s also been a regular newspaper columnist, was chairman of the Bank of New Zealand in 1989 and is a director of the New Zealand Investment Trust plc.

HIS ADVICE: Bruce and Judy
Bruce and Judy are exposed to any protracted downturn in the real estate market on account of uncertain and changing income but rising mortgage payments. The $100,000 inheritance should go directly towards paying off the $90,000 floating mortgage with the balance as a contingency fund.

Their indicated $60,000 per annum retirement objective suggests that when they were both working and earning around $80,000, little saving took place. Clearly little saving is likely with children unless Bruce’s new product succeeds beyond current year targets. With relative uncertainty around their family size and earning circumstances any non-tax-deductible debt that can be repaid should be, with the couple ultimately appreciating, I suspect, the lifestyle freedom that affords.

Given the real estate clock ticking they need to either meet the market on the Kawhia land or risk down the track being forced to sell the presumably highly marketable Coromandel bach. With the Kawhia land sold the proceeds (say, $130,000) are available to either initiate home improvements or (preferably) retain on deposit until the family’s future income level is more assured. If Bruce’s new software product disappoints, then it’s conceivable in 12 months’ time that paying down the $150,000 mortgage shifts up in priority compared to home improvements.

After the exceptional real estate price rises of recent years it is hard to envisage debt being other than an impediment going forwards (contrary to the experience over the past five years). By paying down debt and consolidating their net asset position at this time Bruce and Judy are in effect cashing in their chips and avoiding any risk of going backwards in the event of income disappointments, rising interest rates or ‘discretionary’ holiday home/lifestyle block prices being adversely impacted by the imminent downturn.

In effect, they are currently choosing to save via real estate and I would not discourage this. Sensibly located Coromandel baches are likely to continue to prove popular. My advice is oriented towards ensuring they retain both their home and the bach. I would recommend they return for updated advice in, say, two years.

John and Maria
With net ‘investment’ assets (excluding their home) of $750,000 and currently implied savings of, say, $50,000 per annum over the next five years (a total $250,000) John and Maria are in no position to contemplate retiring at age 50 on $80,000–$100,000 net.

In current conditions a 3.5% net cash yield (after investment fees and tax) is as much as one can bank on from a medium risk balanced portfolio (such as shares, bonds and/or rental property) for a couple with 15-plus years to bridge before receiving NZ Super. John and Maria, by simply stating that they are comfortable “with medium- to high-risk investments” cannot, to my mind, be reliably put into medium- to higher-risk financial assets. Like many Kiwis, their savings background appears to have been property focused, so suddenly taking on sharemarket risk is a recipe for trouble. The trick to sharemarket involvement is to enter cautiously and not get shaken out at the bottom.

These folks need to resign themselves to working longer, spending less (and saving more) and/or lowering their post-retirement requirements if they want any chance of an ‘early’ retirement. Working till 55(ish), saving $70,000 per annum and looking for $50,000–$60,000 per annum (excluding New Zealand Super) in retirement begins to make sense. That implies approaching $2 million of savings to commence retirement with.

Both the $100,000 inheritance and anticipated February 2006 property development gain should be used to substantially pay down their current $271,000 of combined mortgage, credit card and March 2006 tax liability. The next year’s savings (say, $70,000) should clear the balance of debt.

Thereafter at age 45 (average), and a medium-risk profile, of the anticipated $70,000 annual savings I’d recommend a 50/50 risk (shares)/stable (fixed interest or rental property) mix of assets. Depending on how property and equity markets perform over the 2007–15 period it will take seven to ten years to build towards $2 million of investment assets (excluding their home) from which a reliable $50,000–$60,000 per annum (net) can be anticipated.

Readers will appreciate that none of this is rocket science — just a realistic view of likely limited price appreciation from asset markets (real estate and/or shares) over the next five to ten years. Recent times have witnessed exceptionally strong global price appreciation in most physical and financial asset markets on the back of very low interest rates and rising indebtedness. It would be rash to believe such conditions will continue.

Cost: An hourly rate of $395 (ex GST) or an annual retainer based on percentage of assets. For example for $1 million of the latter amounts to $4,500 (ex GST), $2 million equals $5,400 (ex GST).

Murray Weatherston
Financial Focus
An economist by training, Murray Weatherston is a financial planner and advisor with 30 years of experience in business economics, finance and investments up his sleeve. He set up the company Financial Focus in 1989; is a founder member, past chairman and current board member of the Society of Independent Financial Advisors; and is a former national chairman of the Investment Advisors and Financial Planners Association. You may have also heard his advice over the airwaves — he’s been a regular commentator on matters financial (and how they affect everyday New Zealanders) on Radio New Zealand’s Nine To Noon programme for about ten years.

HIS ADVICE: Bruce and Judy
Their paramount concern for the next few years is going to be paying their regular living costs, without worrying about saving for retirement and/or their children’s education. With Judy’s earnings dropping because of the birth of their first child, and Bruce’s income uncertain because of his self-employment, their income/expenditure balance is going to be a bit tight.

They have existing mortgage debt of $240,000 and wish to spend some $100,000–$200,000 on renovations on their house. I am a fan of getting renovations done in one fell swoop and as early as possible — it reduces disruption and gives the longest benefit from appreciation of the end result.

They have cash resources of Judy’s inheritance of $100,000 and expected proceeds of $150,000 from the sale of their Kawhia land. They need to be made aware of the relationship property implications of how they deal with the inheritance. They need to make an explicit decision now as to whether it is to become relationship property or whether it will remain Judy’s separate property. In the latter case she could lend the money to herself and Bruce jointly.

I would advise them to utilise these resources to pay off their existing floating mortgage and to fund the first $160,000 of their house renovations. Depending on how much the renovations actually cost, they will either have some money left over to pay down some of the other mortgage or they will have to borrow a bit more to complete them.

I would advise them to allocate all of their savings for the next few years towards the mortgage until it is down to a minor amount (say $50,000) before worrying about retirement or education funding. Paying off the mortgage reduces their fixed expenses, while it is equivalent anyway to investing at an after-tax rate equal to the mortgage rate.

As for their retirement target, assuming they work till 65, when under current legislation they will get approximately $20,000 per annum from New Zealand Super, they are going to need to build a capital sum of some $800,000–$1 million expressed in today’s purchasing power to provide the other $40,000 (inflation adjusted) spending power they desire. They could reduce this target by about a third if they are prepared to spend all their investment capital in retirement. They will need to save around $30,000 per annum (inflation adjusted) for 20 years to build $800,000 by the time Bruce is 65.

John and Maria
Their aim is to retire in five years’ time and spend about $80,000–$100,000 per annum when retired. They haven’t got a show, unless …

To generate an inflation-adjusted after-tax income of $80,000–$100,000 per annum from age 50 entirely from investments, I reckon they are going to need to be debt free on their houses and to have a net invested capital of somewhere around $2 million in today’s money. This excludes any money tied up in their house, beach house and other lifestyle assets.

They are too young to consider a capital drawdown to enhance their spending above the annual income generated. If they earn a real after-tax rate of return of 5% per annum (which is much more than most investors earn), they will need exactly $2 million to generate $100,000 per annum to spend.
At this time, their investment assets are $111,000 and their debt is $271,000. They are therefore starting at negative $160,000 and they need to get to $2 million in five years.

If they sold their second home for $850,000, their current net investment worth rises to $690,000. To turn that into the required $2 million within five years would require them to earn over 20% per annum after tax and inflation. If they were lucky they might, but that wouldn’t be an orthodox strategy. Of course selling the second home might just reduce their present lifestyle.

I would have to have a serious discussion with them about what really mattered to them before giving any more advice to them.

Cost: For these customers I would work on an hourly rate of $200 (ex GST), and reduce any product entry fees they might otherwise have to pay to zero (although I wouldn’t imagine either couple would be buying much product).