Retire rich in 2022

By Frances Martin and John Noble

Sunday 1st September 2002

Adam Parore learned the hard way that he wasn't going to retire young and rich playing by the old rules of investing. When the ex-Black Cap cricketer bought his first house in 1995 at the tender age of 24, the property in upmarket Remuera looked like a stunningly good investment. Auckland homeowners had been scoring double-digit capital gains for much of the previous two decades. How could he lose?

"I guess, like a lot of Kiwis, I dreamed of owning my own home, then sitting back and watching its value increase 30% in two years," says a now much-wiser Parore, who's retired from cricket to become a broker for JB Were. The reality, of course, is that Auckland house prices dived in the late 90s - which, unfortunately, was when Parore wanted to sell the house to buy an apartment in the city. Though he didn't lose money on the Remuera property, his dreams of making easy money were shattered. He thinks of it as his worst investment because it fell so far short of his expectations.

Though prices have perked up again, the megaprofits once made from property are almost certainly a thing of the past. That means thirtysomethings like Parore need a new game plan if their goal is to retire young and wealthy. For Parore, who has degrees in commerce and law, being rich means having choices about whether or not he works, and what work he does.

"I've always wanted to retire early and be able to spend time on leisure activities. But while it would be great to be able to go fishing all day, I think I'll always need new challenges. I feel better if I'm chasing a new goal."

So how much money would an ambitious 35-year-old need if they wanted to retire in comfort at 55? A debt-free couple with a reasonable house and car and no dependants could retire on a pre-tax income of about $50,000 a year, in present-day terms. Assuming average inflation of 2.5%, $82,000 in 2022 would have the same buying power as $50,000 now.

Chances are superannuation will be means tested by then and our couple need to be well above the limit, so all their income will need to come from investments. They can expect to live to 90, more or less, so their savings must keep up with inflation as well as provide income of $82,000 in 2022, $84,000 in 2023 and so on. Prudently invested, they can expect an average return of 6% as income and 2.5% as growth. And as they're hard-nosed businesspeople (how else can they expect to retire rich in 20 years?), they'll aim to exhaust their capital just as they die, leaving only the house for their children or to support themselves if they live longer than they expect. To achieve that, they'll need invested capital of about $1.15 million in 2022. As well, they'll have assets - property, car and so on - worth about $700,000. That's a $300,000 property in present-day terms, plus all the extras.

The bottom line is that our couple's total worth must be about $1.8 million in 2022. So how do they get there? Next year they must start by investing about $18,000 in growth assets like shares. In 2004 the amount will increase slightly to $18,500, to take account of inflation. And it should keep creeping up each year to keep pace with inflation and pay rises. If all goes well, our happy couple will hit their $1.15 million target by 2022.

Of course, they could indulge in the retire-young fantasy on less money if they're prepared to live somewhere cheaper. Take the example of "Jack". After a dissolute and irresponsible youth, the Kiwi settled down to a menial job, lived frugally and, with the help of an inheritance, amassed $300,000. He learned Spanish, moved to Mexico, bought a house in a provincial capital and married a schoolteacher. He now lives the hidalgo life on the interest - writing and self-publishing, when he's not with his amigos in the cantina. A truly rich life, all for $300,000. It's even cheaper in Indonesia, but more risky.

How to make a million

Apart from winning Lotto or being born into the right family, there are three (legal) ways our couple can get their hands on a million dollars. One or both of them can become senior executives in a large organisation, they can start a successful company or they can live prudently and invest wisely. For the vast majority of us, options one and two aren't goers. That leaves number three.

So what have the couple got going for them? First, New Zealand is a good place to invest. The market is well controlled and the economy is open and stable. Second, there's no capital gains tax and interest charges incurred in running a business are generally tax-deductible. That means - despite Parore's experience - investing in property can give high returns.

What's going against our couple? They might be their own worst enemies. The choice between living high while the money's coming in or investing for the future is always a tough one. Then there are those tempting silver bullet offers that promise them instant riches but end up wasting their money. The biggest enemies of successful investing, however, are inflation and taxation. Deduct them from the 7% or so return on a bank term investment and the net return is closer to about 2%. Our couple has to do better than that.

Traditionally, New Zealanders invested in their houses and in company or government superannuation schemes. The idea was to continually upgrade the house as inflation and pay increases allowed. When couples retired, they sold at a huge capital gain, bought a small retirement house and pocketed the difference. That supplemented the super scheme - often around 40% of final salary - and the universal pension. Nowadays, the Reserve Bank has put paid to inflation-fuelled jumps in house prices and company super schemes are much less generous. Our couple is not going to get rich using the old tactics.

Is your house a good investment?

There are good non-financial reasons for buying a home. The mortgage is a form of compulsory saving, the house can be changed to suit personal tastes and the owner gets a sense of security.

But is it a good financial investment? Compare the costs of buying or renting a $300,000 house. If you opt for the latter, you pay weekly rent of $350 but can invest your $75,000 savings at 9.5% a year. If you buy, your savings become the deposit and you borrow another $225,000 at 7% for 20 years. On top of this, you'll pay about $2650 a year in rates, insurance and maintenance costs. All up, your repayments will be about $403.50 a week.

If you buy and simply make repayments over the 20-year term, you'll end up with a house worth $492,000 (based on inflation of 2.5% and no extra capital gain) and you'll have spent (in 2022 dollar terms) $708,600.

On the other hand, if you rent, in 20 years your invested savings would have earned $460,000, and it will have cost you (again in 2022 dollar terms) a total of $702,000 including rent.

On these figures, buying is better but not spectacularly. That said, the outcome can easily swing the other way if different mortgage rates and investment returns are used, so the buy/rent decision isn't clear-cut. But for those who do opt to buy, Donal Curtin - a former BNZ economist who now runs Economics New Zealand - has this advice: "Pay off the mortgage, it's the best investment you can make." Curtin, a consultant whose clients include funds managers and parliament's finance and expenditure committee - says speeding up mortgage repayments was the best investment he's ever made. "I went on a BNZ roadshow many years ago. After five days of listening to the bank telling people they should repay debt as fast as they can, I went in myself and asked what would happen if I increased my payments. The upshot was that it reduced the term of my mortgage from 18 years to eight."

More investment options

Other investment choices for our get-rich couple are shares, managed funds, investment property and hedge funds. Of all commonly available investments, shares have historically shown the best returns. Only sharebrokers can buy and sell shares, which is why financial advisers tend to only push share investments as part of managed funds. Buying shares directly, rather than through a managed fund, has some advantages. Unless you're a trader, capital gains are not taxed, whereas they are for most managed funds. Managed funds also incur regular management fees, whereas you only pay a fee when buying or selling shares directly.

With the amounts of money our couple is investing, most sharebrokers will be enthusiastic about giving them advice. How good this advice is depends on the sharebroker. The advantage of managed funds is that a professional manager will look after their money, and they'll avoid the "eggs in one basket" risk. By spreading our couple's money over several assets types - property, bonds and shares - managed funds reduce the danger of them losing it all.

Of course, direct share investments can also be diversified to reduce risk. But our get-rich couple needs to remember that diversification also waters down the return they'll get from only holding shares in the most successful firms. They must also bear in mind that it's much easier and cheaper to change sharebroker than fund manager.

Parore's advice to our couple is to stick with investments they understand and are interested in. "If you are interested in something, you'll take the time to learn about it." Diversification is good, but don't buy things you don't understand. For example, capital notes investments have become flavour of the month with shell-shocked share investors looking for somewhere safer to invest. What some don't realise, though, is that notes issued by public companies still carry some equity risk.

Shares and time are the two key ingredients of wealth, Parore says. "Long-term international shares have returned about 8% a year. The way to generate wealth is to buy a diversified portfolio of international and New Zealand shares at age 20, leave it till you're 60, and let compounding do the work."

Parore chooses not to invest in shares himself because of his current role with JB Were. He has opted for, yes, property again, cash (term deposits) and bonds.

As for the countries and types of shares you should invest in, economist Curtin says: "If I found $50,000 in the morning and was looking for a big payoff over the long haul, I'd be looking at places like China and Eastern Europe, and at smaller companies." Yes, he says, horrible things can happen to these sorts of investments. The Asian crisis and Russian meltdown are still fresh in his memory, too. But long term, these are the places to be if you want to earn decent money.

Sure, there are good pickings to be had in the New Zealand and Australian share markets, where prices currently look cheap by world standards, he says. But any 35-year-old wanting to retire rich at 55 needs to think growth stocks, and that points them towards small companies and emerging markets.

Curtin says the rules of the investment game have changed in the past 20 years. Back then it was about beating inflation and government regulations, hence the popularity of things like property and insurance bonds. In future, the biggest earning investments will be linked to new technologies - which tends to point long-term investors towards listed and unlisted shares, he says.

His other advice on share investing is to always sign up for dividend reinvestment schemes. "It's a painless way to build up capital because if you don't get the money in the first place, you can't spend it." Quiet accumulation is the key to retiring rich.

Of course, if our couple wants a bit more excitement they might try hedge funds. The advantage of hedge funds is that they tend to do well when markets are volatile, hence the name. Usually, they invest in derivatives - for example, selling shares they don't own in the hope the price will go down before they have to pay. The derivatives market is not normally accessible to ordinary investors in New Zealand, but it is in the US. Hedge funds are often highly geared and are relatively long-term investments - 10 years or more. The target returns are up to 20% a year, but the risks are also high. Some offer guaranteed capital repayment, but this is a measure of their risk. For obvious reasons, they should only be one part of our couple's portfolio.

Bricks and mortar

The big advantage of investment property - not the house you live in - is that the interest on the mortgage is tax-deductible, while the capital gain isn't usually taxed. By negative gearing - borrowing so much that your outgoings (mostly interest) exceed the income from the investment - your taxable income is reduced. It could even take you into a lower tax bracket. So, depending on tax, returns of 10% or more are potentially possible if the property's in the right place and you're lucky enough to buy and sell at the right times.

But the risks are very high. Just look at Parore. Property investors must survive times when the property sits empty, or when tenants trash the place and skip town. They must ride downturns in the property and rental markets - even harder when the property is negatively geared.

Despite all the risks, investment property remains an attractive option, according to economist Rozanna Wozniak. Of course, you'd expect her to say that - she's a former ASB Bank senior economist who now works for mortgage broker Property Pack. But to be fair, she's just put her money where her mouth is and bought an Auckland investment property.

"There's still money to be made in property, it's just that the easy money's gone now that high inflation's a thing of the past." The trick now is to make sure you're getting a decent return from the rent, rather than just relying on making capital gains, she says. The importance of rental yields depends on where you're buying. In Auckland, where population growth is still pushing up prices, yields are slightly less important. But in slower growth towns like Wellington, they should be a make-or-break part of the decision to invest, she says.

Who wants to retire anyway?

So it's 2022, the share market's up and our couple have their one-and-a-bit million. What do they do now? Move their money into safe income-producing investments and sit back to watch the world go by? Unlikely. Play golf? Maybe.

Keep on doing what they've been doing so successfully? Most likely.

They're still young, relatively speaking, with 30 or so years of life still to go. So what was all that talk about retiring rich? That's for people who don't like what they're doing, isn't it?

How the smart folks do it

Unlimited quizzed three ordinary Kiwis on how they built up their retirement stashes. These guys aren't fantastically rich, nor are they daring entrepreneurs or share market whizz-kids. They're just blokes who worked their day jobs, put money aside and, with a combination of smart investing and luck, ended up independently wealthy. Not surprisingly, they're shy talking about their wealth and asked not to be identified. They're all men, simply because we struggled to find an independent woman aged over 55 who fitted the bill. Most women of that generation built up assets in conjunction with their husbands, we were told.

Case study one: John, a public servant-turned-consultant

John started his working life as a government engineer in the power industry. Thirty years later he quit, shifted to Auckland and went into business as a consultant. He still does the odd bit of consulting work - for fun and to help fund overseas holidays.

John says quitting that safe government job for the uncertain world of consulting was the best "investment" he ever made. As luck would have it, his previous experience meant he could milk a niche in the energy consulting market. Swapping his South Island home for an Auckland one also proved a bonanza. As well as making a capital gain on his Kohimarama property, he's been able to subdivide it, build on the back section and sell the front property.

His other lucky breaks included joining a government superannuation scheme that paid handsomely, and investing in insurance bonds at the right time.

John's investment lesson: Don't let fear of failure stop you grabbing an opportunity.

Case study two: Joe, a former middle manager

Joe quit a safe job at age 37 and headed overseas after being told he would soon die from a lung ailment. When he didn't, he came home and built a management career, before falling out with his employer and resigning. At the time, he owned a portfolio of shares and four properties: three in Auckland and one on Kawau Island.

Joe bought the properties using his bonuses. "I'd live on two-thirds of my salary and save the one-third the company paid as a bonus. I didn't borrow much, I pretty much built the first two houses myself." The Auckland houses were rented, an investment route that in hindsight Joe wouldn't recommend. The returns are relatively low and having tenants is a headache. "You never know who you're going to get - I've had drug dealers, you name it. One tenant destroyed the place a week after it was redecorated."

He's since sold the properties, given the shares to his ex-wife in the divorce settlement and bought a new home in the winterless north. Most of his money is now invested in fixed-interest securities and a small business that someone else runs.

Joe's investment lesson: Don't be too greedy. Spend a bit less than you earn and you'll end up a happy person.

Case study three: Dave, an accountant-turned-academic

Dave was 35 when it dawned on him that he'd better start saving if he wanted to retire in comfort. Although by that time he was a qualified accountant on a pretty good salary, he took a part-time job lecturing in finance to boost his income. However, it was a stint working in Asia - where his take-home pay was three times what it had been in New Zealand - that provided the beginnings of his nest egg.

Since returning home he's dabbled in shares, bought an investment property and, during the 80s, done quite well out of inflation-proof bonds. He's kept debt to a minimum and steered clear of investment schemes promising the moon.

Dave's investment lesson: Make as much money as you can overseas.

Don Brash's tips for low-risk investment

Former Reserve Bank governor Don Brash virtually ran New Zealand's economy for 14 years and he's now a National Party MP. What does he do with his money? Surprisingly, it's invested similarly to many other Kiwi nest eggs. About 35% is in shares, 25% is in fixed-interest securities, a small amount is in forestry and the remainder is tied up in his family home and kiwifruit orchard.

The difference is that Brash largely ignores one of the financial planning industry's golden rules: Kiwis should buy overseas shares. Several years ago he cashed up most of his international shares, leaving mainly New Zealand shares in his portfolio. "I can see the logic in saying the New Zealand equity market is a tiny part of the world equity market, so investing offshore makes

theoretical sense. But I think we've seen the benefits of investing locally in recent years."

He is referring, of course, to the two-year nosedive taken by the US and some other world share markets, helped by recent revelations that some supposedly blue-chip US stocks have been fabricating their profits. Brash says one advantage of investing back home is that you get a better feel for which companies are doing well. You can see for yourself if The Warehouse car parks are full or empty. Kiwi shares are also a bargain when you compare their price-to-earnings ratios with those of overseas stocks, he says.

"Maybe in the ultra-long term it makes sense to hold a big proportion of overseas shares, but it certainly hasn't been true in the last five years." In fact, Brash classes selling his overseas shares as one of the best investments he's ever made. Yes, he missed out on some of the late-90s boom years, but he also escaped the latest tailspin. Conversely, he says his other best earning investment has been Kiwi shares.

So what's the biggest lesson he's learned? "There's no such thing as a riskless investment. There are a lot of New Zealand shares that were once regarded as low-risk - like FCL, BIL and Air New Zealand - but they've been a financial disaster for many shareholders, including me."

Maybe one reason New Zealanders aren't great savers is because they've had so many bad investment experiences, he says. Many lost their shirts on fixed-interest investments during the high-inflation 80s. Then came the 1987 crash, the 90s property downturn, the 2000 tech-wreck and the latest international share crash. "Maybe that's why when we do save we tend to save in property investments, which we imagine to be riskless investments."

Personally, he thinks if the government seriously wants Kiwis to save for retirement, it should create some form of riskless investment - one that protects the investment against loss and inflation, and pays a modest return.

So what advice does Brash give to his two adult kids about investing?

"Paying off debt is their best investment. It gives an after-tax return equal to the mortgage rate. Currently that's an after-tax return of about 7-8%, riskless. No other investment is likely to be as good."

Do ya think I'm sexy?

So you've read all the brochures and

visited all the websites; you know where you should invest and how much you must save to retire rich. But there's one thing stopping you - you never seem to have any money. What's going on? Is there some kind of retail conspiracy out there intent on emptying your wallet each week?

Yes, actually, there is, according to the head of ANZ's consumer banking business, Natalie Sutherland. Retailers work hard to part you from your money - two-for-one sales, no-deposit hire purchase and Christmas promotions are just a few of their tactics, she says.

For many people, and women in particular, shopping has become an addictive sport and they can't go home without a win. "There are people who go out with a very specific goal and that goal is to spend money. To go home without a purchase would be disastrous."

But research done by the ANZ in 2000, and updated more recently, shows these spendaholics want help. That prompted the bank to devise a slightly unusual series of ads about saving - unusual in that they portray it as being as sexy as shopping. For example, one ad features three women showing off over coffee. The first brags about the $100 shirt she's bought and the second about a $250 watch. The third, however, reaches in her bag for her bank statement and proudly displays her $8000 balance.

It is too early to say how effective the ads have been in helping smash the retail conspiracy. The bank is still researching the campaign's impact, Sutherland says, though customer feedback so far has been good.

frances.martin@paradise.net.nz; johnnoble2@compuserve.com

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