, November 2007
Niru Verma, 23, lives in Sydney, IT specialist
Niru Verma, 23, lived at home without a car while she studied at university. Her parents took care of her finances and her main expense was splitting the cost of her textbooks with her parents and funding her dancing.
But Niru has accepted a job in another state, and is leaving home to start it early next year.
Her expenses will skyrocket. She will have to pay rent, run a car and pay all her own bills. "I'm realising the hard part is only just starting now," she says. Niru doesn't want to make any wrong decisions about her money, and wants to do more than just get by.
One of Niru's dilemmas is what to do with the $15,000 she has saved from a job that pays around $700 a week. Should she use the money to pay off her HELP debt of $20,000? Or should she invest the money and pay off the HELP debt gradually from her new salary?
When she starts her new job, Niru will be earning $44,700 before tax. From this she'll have to pay $230 a week in rent. Her parents are
happy to lend her the money for a car which she can pay back from her salary. But should she buy a new car or a second-hand one?
Niru wants to build up an investment portfolio over the next 10 years but wonders how she should invest.
"I want to invest early so that I can reap the greatest rewards," she says. "But what should a young person invest in?"
Her medium-term investment goal is buying a home, but the high prices in Sydney worry her.
How does Niru go about building up a healthy deposit?
Vivienne James, financial adviser, Investec Private Advisors
Vivienne is the author of The Women’s Money Book. She is also a financial planner at Investec Private Advisers, where she advises high net worth clients on investing and superannuation strategies.
Congratulations on your job and new start interstate. Your savings discipline shows, and although expenses may rise significantly, this same approach can be applied to your budget next year even if there are little, if any, savings initially.
Regarding your $15,000, I suggest giving yourself some contingency funds just in case. I'd retain $10,000 in a high-interest online account, providing a low-risk 6.5% to 7%.
Because there’s no real interest charged on HELP, I wouldn’t use your savings to reduce the debt. It will be indexed annually to the cost of living (Consumer Price Index/inflation) currently about 3% a year so you’ll be ahead by earning a good interest rate, even after paying tax and HELP gradually from your salary.
When you start your new job you will likely exceed the threshold for repaying the HELP debt to the tax office. The maximum you’d be repaying is 4.5% of your taxable income.
On buying a new or a second-hand car, I'd first ask if you really need one. It's an expensive purchase and you’ll keep spending money on it. It will also lose value through depreciation. If walking, public transport, taxis, cycling or a car pool are not realistic, buy a safe, low-maintenance car.
To reduce the amount of instant depreciation, buy a demonstration or superseded model. A two or three-year-old car may be best in both financial and safety terms. You should also check the difference in car prices between states.
As with any loan, I suggest you adopt a repayment schedule that works for your budget and is within your parents' repayment expectations. It's good to establish a credit history by taking out a loan with a financial institution – the regular repayments you make as well as your previous savings history will illustrate an ability to budget should you require a loan at a later stage.
If you need a car for your job, you should see an accountant as you may be able to claim some expenses.
With building up an investment portfolio, I would invest $5000 into a diversified share and property portfolio through a managed investment fund.
Choose a fund that allows you to add a minimum $100 per month in the future. This can be set aside for your longer term goals and added to, should you have some discretionary savings. This could include a salary increase or you may decide to live with a friend, which reduces your expenses.
Once you settle into a savings pattern, it could be worthwhile borrowing to invest, but this is probably a couple of years away.
As for buying a home, I wouldn't rush into this as it’s such a big financial commitment at your age. Down the track there are benefits to buying a home that you will live in – such as reduced stamp duty and a first home owner's grant (which is rumoured to be increased due to the affordability issue you referred to). This isn't available for the purchase of an investment property.
Mark Serry, head of strategic advice, London Partners
Mark is a CFP [Certified Financial Planner] and head of strategic advice at London Partners, a firm that believes no one individual can be on top of investment markets and tax, superannuation and estate planning legislation.
The HELP system, which replaced HECS on January 1, 2005, has a 10% bonus for early repayments. Outstanding HELP debts increase with inflation. The only way to really analyse your best option is to crunch the numbers.
You would need to contribute $9091 in order to pay off $10,000 of debt. One alternative is to invest the $9091 and then repay the debt in advance at a later stage. Assuming the government doesn’t change the rules (10% bonus was previously 15%), you only need to achieve an after-tax investment return that equates to the Consumer Price Index (CPI) generally viewed as poor with online cash accounts providing higher after-tax returns.
However, this would require you to repay the loan and receive the bonus before the debt is run down by deductions from your pay. This will ensure you receive the 10% bonus.
Buying a car is not simply a financial issue, but there is no doubt second-hand cars are much better value. As soon as a new car drives off the lot, its value falls.
Growth investments such as shares and property are best for longer term wealth accumulation.
They can be volatile in the short term, and you should expect to experience falls in the value of your investments. However, they have consistently provided superior long-term returns, which are achieved in a far more tax-effective manner.
If you’re just getting started, managed funds could be suitable in order to get exposure to a diversified portfolio, which could include commercial property, Australian and international shares. There are also some quality listed investment companies (a share on the stock exchange that owns a basket of other shares) that could provide a suitable solution.
You may also consider margin lending borrowing against your investments and savings. If you have really helpful parents, you could borrow against their home. I truly believe that gearing or borrowing to invest at appropriate levels, with the right controls in place is the most effective way to build long-term wealth.
Property is a large, lumpy investment with high costs: stamp duty, legal and agent fees. Rental yields are still low and there could be unexpected costs or interest rate rises.
With your situation changing dramatically, you’d be locking yourself into something with little flexibility. I assume you are suggesting an investment property because it would be a smaller property or in a lower-cost suburb. I would not suggest buying low-quality property and it does not appear that you would have the deposit necessary to purchase property.
Keep reading - next article