Understand Interest & Principal on Your Mortgage Payment

Do you know how much interest you are paying on your mortgage? No, I am not talking about the interest rate. How much interest in the dollar amount you are paying on your mortgage? Also, what proportion of your mortgage payment goes to interest? Do you know how many years it will take to pay off half of your mortgage? (spoiler: more than 20 years with 5% interest rate)

Most home owners know their mortgage payment like the back of their hand, but not all of them can tell you how much interest is in the payment. Some new house owner is surprised when they read the mortgage statement and found out how little money went to mortgage repayment. Let’s look at the interest and principal on our mortgage payment. I will be focus on the simple interest mortgage with a fixed interest rate and fixed payment amount for 30 years.

Interest and Principal

Every mortgage payment in New Zealand will contain Interest and Principal.

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The principal is the part of your mortgage payment that goes to repay the amount you borrowed. It starts out with a small amount and increases on every payment. Eventually, the total principal paid will be equal to the amount you borrowed.

The lender (usually Bank) took up risk to borrow you money on a house purchase. Interest is the reward for taking that risk. They are profit for the lender and expense for the borrower. Interest rate could be different for each different borrower. Usually, a low-risk borrower will have a lower interest rate compared to a high-risk borrower. At the lender’s point of view, to take a higher risk borrower, they will charge higher interest to compensate that risk. A significant amount of mortgage payment will go to interest payment at the beginning of the mortgage and decrease on every payment.

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Proportion of interest and principal on a 5% interest, 30 years mortgage

How Much Interest you are paying?

We will use the following simple interest mortgage as an example.

Mortgage size: $500,000
Term: 30 years, pay monthly
Interest rate: 5%
Monthly payment: $2,684.11

For your first payment, $2083.33 will go to interest and only $600.77 will go to principal payment. That’s 77.6% of your monthly payment go to interest expenses.

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Breakdown on your mortgage payment during the first year

For the first year, you will pay $32,209.30 in mortgage payment, $24,832.47 will go to interest, and you only reduce your mortgage by $7,376.83.

Why most of your payment went to interest in the beginning?

You may be surprised only 23% of your mortgage went to principal payment and wonder why most of your payment went to interest in the beginning. I was angry and thought it wasn’t fair. So I dug in and worked out how the banks come up with that amount.

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First, under the terms of the mortgage, interest is calculated daily and compounded monthly. What it meant was the bank will charge interest on the mortgage every day and recalculate the mortgage amount and interest every month. The interest rate (5% here) is an annual rate, so one day of a 5% interest will be 5% / 365 = 0.013699%. Bank will apply that one-day interest rate to your current mortgage amount $500k. At your first month, you will be paying $500000 x 0.01369% = $68.49 every day on interest. Here is the daily breakdown on the first month of the mortgage.

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You may notice on 31/7, the interest amount is only $28.54. The reason is that when we calculate the monthly mortgage payment, we are not calculated based on how many days in a month. We just divided the full year (365 days) by 12, so every payment got 30.41667 days. That’s why I have to re-adjust the 31st day of July interest by 0.41667. $68.49 x 0.41667 = $28.54.

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On 31/7, you pay $2684.11 for your mortgage. At this point, the total interest is $2083.33, only $2684.11 – 2083.33 = $600.77 go to reduce the $500K mortgage. At 1/8, your new mortgage amount will be $499,399.89 and you daily interest will be $499,399.89 x 5% / 365 = $68.41. At the end of the month, we will accumulate $2080.83 in interest. By paying the same amount of mortgage payment ($2684.11), you will reduce the mortgage by $2684.11 – 2080.83 = $603.28.

When you compare the numbers on both months, your monthly payment amount is the same. Since you reduce the mortgage amount by a little bit in your first payment, the interest on the mortgage at the 2nd month will be reduced. That explains the interest payment will keep decreasing and principal payment keeps increasing. The reason we why most of your payment went to interest payment is because your mortgage amount is high in the beginning. Lots of interest was charged and most your payment went to pay off those interest.

How does pay extra on your mortgage reduce the interest calculation

In my last post, I said one thing you can do to reduce the interest paid on your mortgage is by paying extra on the mortgage. Let put that in our example and see how $100/month extra can reduce the interest.

The first month will be the same as we haven’t made any payment. We will still have $2083.33 interest needs to pay. However, if we increase the monthly payment to $2183.33, we will reduce the mortgage amount by $2183.33 – 2083.33 = $700.78. On your second month, the new mortgage balance is $499,299.22 and the daily interest will be $499299.22 x 5% / 365 = $68.40. At the end of the month, we will accumulate $2080.41 in interest, $0.42 less.

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You may think that just $0.42, hardly make any difference. However, that is the saving on the second month only. You will save more and more each month. Paying extra on the mortgage will have a knock on effect on the mortgage amount reduced. You will end up pay off your mortgage in 27.6 years and saved $42.6K on interest.

Breakdown interest paid by years

Now we took the $500K mortgage break it down by years. Here is what you will pay over 30 years.

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Some interesting facts here:

  • 77% of your first-year payment went to interest.
  • By the end of the mortgage, you will pay $500K on principal and $466.3K on interest. You almost paid twice on your mortgage.
  • For the first 16 years, over 50% of your payment will go the interest.
  • You will pay almost half of the total interest on the mortgage in your first 10 years. Therefore, lenders make half of their profit in 1/3 of the time.
  • After paying 20 years, you still owe over 50% on your mortgage.
  • You will pay off $253K in the last 10 years of the mortgage.

That’s why Bank love mortgages, and it’s their bread and butter. I personally feel angry reading those facts. I put reducing mortgage as my top financial priority. On the other hand, inflation is another factor helping to reduce the ‘real’ cost of the mortgage, we will get into that in another post.

If you want to find out the breakdown on your mortgage payment, you can check out this mortgage calculator on mortgagerates.co.nz.

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

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Understand the Math of Mortgage

I spent a lot of time here talking about investing in New Zealand. However, if I put my money where my mouth is, I spent more money on reducing my mortgage compares to investing. So let’s take a break from investing and talk about the mortgage, which is one the top three investment options in New Zealand.

We are one of the lucky ones who luck into a house before house price went batshit crazy between 2013-2016. However, since we brought Auckland, the mortgage amount is still huge dispute we put down more than 20% deposit. So reducing that mortgage have been my top priority and I spent a lot of time to research and study on mortgages. It turns out the mortgage is just a mathematical formula. If we understand the factor of that formula, how to pay off the mortgage early is not a secret at all.

The Formula of Mortgage

A mortgage is a loan to buy a property. You borrow money from the lender (usually a bank), and you are obliged to pay back with interest. The lender uses the property as security. Here is the formula of Mortage.

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A is the payment on each term.

L is the mortgage amount (or Principal)

r is the interest rate

n is the term

So the mortgage formula based on those four factors and they are interconnected. If you follow the mortgage plan and make the payment each term (usually every fortnight or month), by the end of the term, you will pay off the mortgage and plus interest.

(You don’t need to calculate the mortgage on your own. There are hundreds of mortgage calculator online, I recommend the Mortgage Calculator on Sorted)

Interest and Principle

Each mortgage payment will have interest payment and principal payment. The principal is to repay the amount you borrowed, and interest is profit for the lender. At the beginning the mortgage term, most of the payment went to interest, and only a small part of the payment went to the principal.

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To work out the total interest paid on the mortgage, you will need to:

Payment amount X No. of Terms = Total amount paid

Total amount paid – Mortgage Amount = Total Interest Paid

The Game of Mortgage

 

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The mortgage is a game with four controls.

For me, the mortgage is just a game. It’s a game with 4 controls. The goal of the mortgage game is to minimise Total interest paid by changing payment amount, mortgage amount, interest rate and terms within your abilities. In New Zealand, the size of the mortgage can be range from $100k to $1mil or more. Total interest paid on the mortgage can be 30% – 130% of the size mortgage. This is a high stake game with $30k to $1.3mil of interest to be saved. Yet, the rule of the game is surprisingly simple!

We are going look into each factor and see how they affect our goal to minimise our total interest paid. We will be using the following mortgage as our default example. To keep it simple, I assume interest rate will stay the same during the whole period.

Mortgage size: $500,000

Term: 30 years, pay monthly

Interest rate: 5%

Monthly payment: $2,684.11

Total Interest Paid: $466,278.92 (93% of mortgage size)

Mortgage Amount

The mortgage amount is the main deciding factor in a mortgage. The amount you borrowed is in direct proportion to your monthly payment and total interest paid. More you borrow, more you pay every term and more paid on interest. However, the size of total interest paid compared to mortgage amount reminds the same. In our example, no matter the size of the mortgage, you are still paying 93% more on interest.

In most case, you want to borrow as little as possible.

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5% interest rate and 30 years term, pay monthly

Interest rate

Interest is charged by the lender to the borrower to offset the risk of lending money. It calculated based on interest rate. Interest rate change from time to time due to multiple factors, including official cash rate change by RBNZ,  the cost of borrowing at the lender, the length of the fixed term, demand of mortgage at each lender and more.

Increase interest rate in a mortgage formula will affect mortgage payment and total interest paid. If you took a 5% interest rate and increased that by 0.5% to 5.5%, the mortgage payment will increase by 5.8% but the total interest paid to mortgage ratio jump from 93% to 104%. So you want your interest rate as low as possible.

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$500,000 Mortgage, 30 years term, pay monthly

 

Terms & Payment

The term is how long the mortgage supposes to last and payment is how much you will pay each time. I put them together because they are closely connected in a mortgage. If we increase the mortgage terms, the payment amount will be lower but you will pay more on interest. On the other hand, if we increase the payment amount, we will shorten the mortgage terms.

In the table below, you can see if we shorten the mortgage by increase our payment amount, we will be paying a lot less on interest.

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$500,000 Mortgage, 5% Interest Rate

 

In Reality, What can you Change?

Now we understand those four factors of a mortgage and how they will affect the end game (a.k.a total interest paid). Let’s put them into a real world situation and see how we can change them to our favour. (There are many ways to improve those factors, I only covered the obvious one here)

Reduce Mortgage Amount

Since the mortgage amount decides your term payment and total interest paid, it’s better to have a smaller mortgage. With small mortgage amount, it will come with a small monthly payment amount. You can increase the monthly payment amount without adding pressure to your living budget.

To reduce the mortgage amount for potential house buyer, you will have to put down a larger down payment or choose a cheaper house.

For existing homeowner, you can reduce the mortgage amount when you mortgage terms are up for review by transfer some of your saving to repay that mortgage. (if you have the spare cash)

To be honest, it is difficult for both potential buyer and house owner to reduce their borrowing amount. With those crazy house price these days, most of the potential buyers are stretching to the maximum on what they can borrow and get onto the property ladder. Existing homeowners are already stuck with that mortgage and lender don’t like you pay them back early. So in reality, you don’t have much control on that.

(There are some tricks to reduce that mortgage with right mortgage set up. We will get into that in an upcoming blog post)

Get a Better Interest Rate

Bad news, you don’t have much control on interest rate either. The Interest rate set by the lender and each lender will have the identical interest rate. What you can do is make yourself a better borrower.

Banks love mortgages as this is their bread and butter. If you are a good borrower in their eyes, they will offer you a discounted interest rate to get your mortgage business. What consider a good customer from the Bank:

  • Owner Occupied Property, mean the mortgagor live in that property
  • Work full time with a stable income
  • Employed by established company for a long time
  • Clean credit history
  • No other debt
  • DINK (Double income, no kids)
  • New Customer
  • Willing to change your ‘Main Bank’
  • Have 20% or more equity in the house
  • A good quality house in a good location (not leaky home or potential leaky home)

Bank will consider that as a low-risk lending and happy to offer a small discount on the interest rate.

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However, the free-market is still the primary deciding factor on the interest rate so there is not much we can do about that. Kiwis used to pay 18% interest rate in 1985. Before GFC in 2008, the mortgage rate was around 8.4%. We are experiencing a historic low in interest rate at 2017.

Increase Payment Amount & Shorten the Terms

Payment and terms are the most important factor in the game of mortgage because we have control over it. When the bank says you need to pay $2684.11 for your $500K mortgage, it’s not the absolute amount! It’s just the minimum amount you’ll need to pay. You can always tell the bank you what to pay more. Let’s see how the term and total interest paid change when we pay more on our mortgage.

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$500,000 Mortgage, 5% interest rate. Minimum monthly payment at $2684.11.

By simply put $1/day extra into your mortgage payment ($30/month), you will shorten the mortgage by 9.6 months and save $13.8K on interest. If you can add $10/day extra into your payment, you can pay off your 30 years mortgage in 24 years and saved $106,644 in interest.

It may be hard to do in the first couple of years, but your income will likely to be increased while the mortgage payment stays the same. Combine that with careful budgeting and frugal living; you can put more and more into your mortgage and reduce the interest paid.

The Secret of Paying off Mortgage

Now you understand the four factors of the mortgage and how you can improve them. The secret of paying off mortgage fast and win the game of mortgage is very simple.

Get the smallest amount of mortgage with the best interest rate discount, pay it off with the biggest payment amount you can afford.

That’s the fundamental principle of getting out of debt; it does not only apply to the mortgage but other consumer debt as well. Every single tips and trick that help you pay off mortgage fast will always chase back to this principle. We will cover lots of them in the coming months. Stay tuned.

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

Top 3 Investment Options in New Zealand

I spent a lot of time on my blog talking about ETF and index fund investing in New Zealand. I believe they are great options and an import investment vehicle to help me achieve financial freedom.

However, there are three investment options are objectively better than ETF and Index fund with low entry requirement, low risk and high (sometimes guarantee) return. They are the low hanging fruit of personal finance that everyone should do it. Those three investments options are pay off consumer debt, join KiwiSaver and reduce the mortgage. I will go through each one of them and talk about they risk and return.

No.1 Pay off Consumer Debt

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You want to kill those consumer bills ASAP!

Credit card debt, car loan, payday loan, personal loan, hire purchase, P2P loan… All of those are consumer debt. Debts that are owed as a result of purchasing goods or services that are consumable and do not appreciate in value. Those debts usually have high-interest rate and exorbitant admin fee. If you are paying interest on depreciating assets, they are dragging back you financially. You won’t go forward if most of your income goes to those stupid bills. You need to get rid of them ASAP!

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Paying off debt is Investing

This concept may not be obvious to everyone but PAYING OFF DEBT IS INVESTING. For me, debt and investing are just two sides of the same coin. One side (investing) is to increase your wealth (with a given level of risk). Like you buy NZ Top 50 ETF from SmartShares, if the share price increase and they pay out a dividend, your wealth increased. On the other hand, the shares price may drop, and your wealth will decrease. So there is a risk of losing money with investing.

The other side of the coin (debt) will reduce your wealth. If you have $1000 credit card debt with 20% interest, your interest expense for the first month will $16.67. So your wealth reduced by -$16.67. Unlike investing, the debt will guarantee to reduce your wealth and drag you back financially. Therefore, reduce your debt will move you forward financially, guaranteed.

Whats the return and risk?

I will use a simplified sample to present the financial effect of paying off debt.

Assume you have $1000 in cash and $1000 credit card debt with 20% interest.  If you keep the $1000 in cash and don’t pay it off credit card debt, in one year, you will be $1000 x (1 + 20%) =  $1200 in debt. Financially you moved backwards by $200.

Now, you invest the $1000 cash in a 12 months term deposit with 3.25%. You still keep your $1000 credit card debt and not paying that off. In one year, your earn $1000 x 3.25% = $32.5 in interest from your term deposit. Take away $9.75 as tax; you will have $1022.75 in cash. On the other hand, your credit card debt still cost you $200 in interest. So financially, you moved backwards by $177.25.

Instead of invest that $1000 into a term deposit, you use that $1000 to pay off your credit card debt. Since the credit card debt is gone, it won’t occur interest. In one year, you will be in the same financial position.

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Look at all three scenarios, pay off credit card debt resulted in the best financial position. As you putting that $1000 cash to pay off your credit card debt, you are in fact getting 20% return on those $1000. Unlike other investment, those returns are Tax-free and guaranteed. If you need to get 20% after-tax return on investment, the pre-tax return will need to be 27.77%. That is an excellent return on investment. I am not saying you can’t get 27.77% return out there, but I am sure there is no investment (except KiwiSaver) can guarantee a 27.77% with no risk.

If we look that those high-interest-rate consumer debts, paying them off will be a great return for your money. Also, paying off consumer debt will reduce your financial risk and stress. You will be in a much better position when you negotiated mortgage term and resulted in better deals. That why paying off consumer debt is one of the top three investment options.

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What about Student Loan?

The student loan in New Zealand is interest-free as long as you are staying in the country. The payment only occurs when you have income. So you should just pay it off as you’ve got income. I would not be paying them off early unless you plan to leave the country for a long time.

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No. 2 – Join KiwiSaver

KiwiSaver is a voluntary, work-based savings initiative to help you with your long-term saving for retirement. It’s designed to be hassle-free, so it’s easy to maintain a regular savings pattern. Once you join KiwiSaver, at least 3% of your income will invest into a KiwiSaver fund. You can only access those fund until you use it to buy your first home or turn 65. What makes KiwiSaver to be a top investment option is because of employer contribution and member tax credit.

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Employer match

If you’re over 18 and is a member of KiwiSaver, when you make your KiwiSaver contribution, your employer also has to put money in. By law, the employer required to contribute at least 3% of your income. The employee can choose to contribute either 3%, 4% or 8% but employer only requires to match at 3%. Some employer may decide to match 4% or 8%.

It may seem you will be making 100% return on investment on your 3% contribution. However, IRD will take out tax from you employer contribution, so the actual return on your contribution is about 67%-89.5%. (You can find out why here)  It’s still an unbeatable risk-free guaranteed return.

Member Tax Credit

KiwiSaver Member Tax Credit is to help you save on your KiwiSaver. The government will make an annual contribution to your KiwiSaver fund (a.k.a Free money). The amount is $0.5 on every dollar up to $521.43. You will have to be 18 or above to receive the tax credit. This is a way of government help you save for your retirement and encourage you to join the plan. It cap at $521.43 so it will benefit for the most full-time employee but not favour mid to high-income earner.

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Return on Employee

If you are over 18, fully employed, annual income at $55,000 before and contribute at 3%. Your minimum return on your contribution will be like this.

Your annual contribution (3%): $1650

Employer contribution after tax: $1361.25

KiwiSaver Member Tax Credit: $521.43

The return on your investment: (1650 + 1361.25 + 521.43 – 1650) / 1650 = 114%

Return on Self-Employed

If you are self-employed, you won’t get the employer match, but you are still entitled to member tax credit as long as you make a minimum manual contribution for $1042.86

Your manual contribution: $1042.86

KiwiSaver Member Tax Credit: $521.43

The return on your investment: (1042.86+ 521.43 – 1042.86)/ 1042.86 = 50%

Those are only your base return; you are likely to make investment return on your KiwiSaver Fund as well.  Here is a couples data on a KiwiSaver fund with different income level. The KiwiSaver fund cost and return data are based on SuperLife 80.

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No. 3 – Reduce your Mortgage

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Mortgage payment can easily be the biggest expenses on most homeowners’ budget. Average first home buyer will spend $1500/month on the mortgage, and it will cost more if you have a mortgage in a major city. Imagine what you can do with that money if you don’t have a mortgage payment.

Return on Reducing Mortgage

Paying off have the same effect on paying off consumer debt. It will give you a tax-free and guaranteed return. The return is not as high as those consumer debts because the interest rate on the mortgage is lower at 4% – 6%. The equivalent pre-tax return is around 8.3%.

Reduce your Mortgage or Invest elsewhere

Some people may think 7-8% is not a very good return, and you can achieve that with other investment options without taking a lot of risks, like the share market. However, I still think paying off the mortgage on your own home is a better option because you are paying off an asset that will provide you with a place to live, offset the cost of renting in the future and the house will increase in value (in the long term for most cases).

If you can’t decide to reduce mortgage or invest elsewhere, ask yourself a simple question: 

If you fully owned your house today, will you borrow $500k on your mortgage-free house to invest in share market? Or you will use your income to invest in the stock market every month?

If you say you won’t borrow on your mortgage-free home (like me), then you should focus on reducing that mortgage now. I basically asked the same questions but put it in a different perspective. If you have the money to reduce the mortgage, but you put it into the share market, you are basically borrowing on your house to share market.

Saving Big on interest expense

Since the mortgage size is usually over $200K (over $500k in Auckland) and the payment terms are 20-30 years. You end up paying A LOT on interest expenses. Check out the chart below.

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For a 30 years term mortgage at 5% interest rate, you will end up paying 93% extra for interest payment. So what will happen if we increase our payment and shorten the mortgage by ten years?

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When we shorten the mortgage term by ten years (-33%), our monthly payment increased by 23%, total interest paid decreased by 37.3%! Only 36.9% of your payment went to interest.

Reducing mortgage may not give you a high percentage return, but due to the size of the mortgage, the saving you are likely to make is in the hundreds of thousands. I will have a series of blog posts in the coming month to show you how to be smart on your mortgage with different setup and tips.

Conclusion

  • The top 3 investment options in New Zealand are paying off consumer debt, join KiwiSaver and reducing your mortgage.
  • Paying off consumer debt is investing. The returns are in the range of 15% – 35%. You will be in a better financial position once you pay off your debt.
  • A KiwiSaver member can enjoy instant return from minimum 50% – 110% due to member tax credit and employer match. However, that money is locked-in until you purchase your first home or turn 65.
  • Paying off return about 7% – 8% on your dollar, not as high compared to other. However, due to the size of the mortgage and interest paid, you are likely to be saving hundreds of thousand of the dollar

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

Sharesies (Beta) – How does it stack up to SuperLife and SmartShares on ETF Investing

Sharesies is rolling out their trial run (a.k.a beta) investments options couple weeks ago. I’ve got their invitation recently and checked out their offerings. Sharesies is currently offering six SmartShares ETFs for their investor including NZ Top 50, AUS Top 20, US 500, NZ Bond, NZ Property and AUS Resources. You can check out their current offers here.

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What is Sharesies

Sharesies is a New Zealand financial start-up company supported by Kiwibank Fintech Accelerator. They are an investment platform where users can make investments with small amounts of money. One of their mission is to make investment fun, easy and affordable.

The main selling point of Sharesies is by paying a $30 annual fee, an investor can invest into multiple investments with the minimum at just $5. Also, there is a $20 credit for the early Beta investor.

Invest $5 into ETF

In comparison, SmartShares ETF initial investment is $500, set up cost is $30/ETF and monthly contribution minimum is $50. So Sharesies is a great way for beginner investor to invest in a small amount into many low-cost, diversified ETFs. It bypasses the $500 initial investment and $30 set up fee with each ETFs.

On the other hand, SuperLife also offers the same ETF in their investment fund with a different management cost. You can check out the detailed comparison here.

While Superlife also doesn’t require initial investment and the minimum contribution can be just $1. How does Sharesies stack up to SuperLife and SmartShares on ETF investing?

Sharesies vs SuperLife & SmartShares

I’ve picked two popular ETF, NZ Top 50 and US 500, to run an analysis for 60 months (5 years). The analysis will compare the result on different contribution level(low and high contribution) for all three services. The low contribution will be at Sharesies minimum requirement, $30 initial investment (for the annual admin fee), $20/month contribution (about $5/week); The high contribution will be at SmartShares minimum requirement, $500 initial on each ETF, $50/month conditions.

NZ Top 50 ETF at low contribution

Here is the fees structure on the ETF

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This is the amount of low contribution and expected return

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So Sharesies have a higher admin fee ($30) and ETF management cost (0.50%), so its expenses should be higher then Superlife NZ top 50 ETF. Since Sharesies are aiming for beginner investor, I put around $5/week as a low-level contribution. The $30 initial investment cost is to cover Sharesies annual fee. Smartshares will not be included in this analysis as the investment amount is too low.

Here is the investment return each year

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Superlife did better as it has a lower management fee and admin fee resulted in a higher return for the customer. The 5-years different is $135.81, 8.4%.

NZ Top 50 ETF at high contribution

This is the amount of high contribution and expected return

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We increased the contribution to $50/month, put $500 as an initial investment and include SmartShares into the mix.

Here is the investment return each year

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SmartShares came out on top despite the fact that they have a higher management cost. The main reason is that Smartshares don’t have an annual admin fee while Superlife charges $1/month. However, if you wish to cash out those Smartshares at this stage, it will cost you at least $30.

The difference between SmartShares and Sharesies is $163.34, 3.3%. Although both services have the same management cost, Sharesies charge $30/year admin fee which brings down the balance.

US 500 ETF at low contribution

Here is the fees structure on US 500 ETF

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This is the amount of low contribution and expected return

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This is more interesting as Sharesies have a lower management (0.31%) cost compare to Superlife (0.44%).

Here is the investment return each year

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Due to the small amount of holding, the lower management cost (0.35%) did not cover the higher annual fee ($30) with Sharesies. Superlife holding was $122.28 more then Sharesies in year 5, 8.1%.

US 500 ETF at high contribution

This is the amount of high contribution and expected return

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Now we will do the same thing by increasing the investment to Smartshares minimum requirement.

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SmartShares USF came out on top with no annual fee and lower management cost. The different between SmartShares and Sharesies at year 5 is $154.75, 3.3%. The different to Superlife is $41.5, 0.9%.

In both scenario, Investor with low contribution level and better with SuperLife. If you have the $500 and $50/month to invest, SmartShares is the cheaper way. (Although I will suggest going with Superlife on NZ top 50. I’ve already covered that in another post)

How about portfolio building?

Since Sharesies investors can bypass SmartShares setup fee and initial investment requirement. So Sharesies is actually a great tool to build a simple portfolio. I will use US 500 ETF, NZ Top 50 ETF and NZ Bond ETF to build a portfolio.

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Here is a balanced portfolio you can easily build with Sharesies. 25% NZ Bond, 37.5% US 500 and 37.5% NZ Top 50. If we keep the low contribution at $20/month, you can put $5 in NZ Bond, $7.5 in US 500 and $7.5 in NZ Top 50.

If you wish to set up something similar in SmartShares, you will have to spend $30 x 3 =$90 on set up fees, at least $500 x 3 = $1500 initial investment and $50 x 3 = $150/month contribution. Not feasible at all.

SuperLife, on the other hand, as my best pick for portfolio builder in New Zealand can easily build the same portfolio. Let’s check out the cost difference.

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Here are the contribution and return

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Here is the investment return each year

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Superlife still edged out at year 5 with $123.15 more, 8.2%. I didn’t do a high contribution comparison here because SmartShares are really not fir for portfolio building.

Conclusion

Based on the analysis, SuperLife is still the better choice on low contribution and most of the high contribution (except US 500 ETF) regarding cost. However, I still think Sharesies is doing something good here.

Sharesies is promoting to young Kiwis who never invested before by providing a straightforward and easy-to-use app. The sign-up process is simple and painless. The interface is robust and delightful. They’ve done an excellent job on explaining each investment options to beginner investment and make it accessible. Check out the screenshots below.

 

 

I don’t mind about the $30 admin fee if that what’s it take for a newbie to start investing for their future. I’ve been telling readers to spend $12/year on Superlife as they have a better user interface and functions over SmartShares. Sharesies interface and user experience are way better than both of them. They made investing as easy as shopping online, which should bring a lot of people into the world of investing.

Sharesies are still in beta, so there are some functions are missing, like reinvest and auto allocation. I am sure Sharesies will continue to improve on their functions and brign in more investment options. Hope more companies like Sharesies will pop up in New Zealand to bring more people into investing.

More investor, bigger the market size, lower the cost!

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

How to Start Investing with Smartshares and How Long will it Take

SmartShares is an excellent way to invest in low-cost, diversified ETF in New Zealand. Especially if you wish to invest in the top 500 companies on US stock market. Smartshares S&P 500 ETF (USF) is a great option for all investors as it is simple to understand, the management cost is low at 0.35% and has a long positive track record. I’ve been getting questions on how to start with investing with various investment service I covered and the most of the questions on Smartshares. So here is the guide on Smartshares.

How long will it take?

Let’s set the right expectation here, its gonna take a LONG time to set up a monthly contribution plan with SmartShares. For average Kiwi investor (without any connection to politician or United State), will take about 2-5 days to set up with most investment services. However, with SmartShares, you will have to spend around 27-53 days. Yes, that is not a typo. Just make sure you are prepared for it.

Sign up with SmartShares

We are going to walk through the setup process for an individual investing $500 into S&P 500 ETF with a $50/months contribution. Before we start, you will need to prepare the following items.

  • IRD number
  • NZ Drivers Licence
  • Bank account number for direct debit
  • Read the product disclosure statement

Go to Smartshares Invest Now page and click on “Apply online.”
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Under investment options, select “Individual”, leave it blank on “Common Shareholder Number” if you are a new investor. Put $500 (minimum) on US 500 (USF) investment and $50 (minimum) as regular saving plan.

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Next page is your personal information and email address. That email address will be your main point of contact. You will receive an email during the set process to confirm your email address.

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Next is your ID verification. Put in your NZ Drivers license details.

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Next, confirm your payment details with your bank account no. Please make sure you have enough fund at 20th of each month.

 

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Next part you will have to review your information and confirm your contact email with an authentication code.

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Here is the authentication email with the code. Screen Shot 2017-04-15 at 10.38.27 PM.png

Once you completed this process, you are done with the sign-up. The next part is the long wait….

What you are waiting for?

The SmartShares signup process is straightforward and painless. However, investors need to wait a long time to check up on their holding. An investor cannot log on to SmartShares to check their holding. SmartShares will direct investor to use Link Market Service to do that. To register for Link Market Service, you will need two pieces of information: FIN (Faster Identification Number) & CSN (Common Shareholder Number). FIN will send to you by mail (physical letter), and CSN will be on your holding statement in an email. You will need those two numbers to prove you own those stock. Check out this page from ANZ Securities on what is FIN and CSN.

The long wait

So here is my timeline on signing up with SmartShares.

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4/5 – I submitted my application on SmartShares website.

8/5 – I got a confirmation email on my SmartShares application and my direct debit.

20/5 – $500 initial investment withdraw from my account, and it supposes to make the purchase at the beginning of June.

6/6 – the purchase happened

7/6 – a letter came into my mailbox with the FIN number. I still can’t log onto Link Market Services because I don’t have the CSN number.

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12/6 – got an account statement from Link Market Service with my CSN number.

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I managed to log into Link Market Service and check out my holding. Yeah!

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So it took 39 days for me. To be fair, I can submit my application on 12/5 or 13/5, it will still make the 20th direct debit cut-off date. So you can shorten 7-8 days there. On the other hand, if you submit your application right after the 20th cut-off date, you will have to wait over a month.

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Why it took so long?

Smartshare is NOT an investment service or fund manager. They are an ETF issuer. ETF is not an investment fund; they are tradable shares. Usually, you will have to set up a brokerage account and pay a fee to buy shares in New Zealand Stock Exchange. The minimum is $30/trade.

SmartShares offer a service allow investor buy shares in a small amount monthly without paying a brokerage fee. If I have to do it in the with a stock broker, it will cost me at least $360/year on brokerage fee alone. I am happy to wait a couple of days to save $360.

If you don’t want to wait that long, you can open up a stock brokage account and buy SmartShares directly on the stock market. It will take 2-5 days to set up a brokage account, and it will cost at least $30/trade.

Hope this blog will set an expectation for you when you sign up SmartShares. Don’t be panic when they took your money for 2 weeks without any communication. Your FIN and CSN will arrive…eventually.

Compare ETF Fund Cost between Superlife and Smartshares (2017 Update)

Recently SuperLife and SmartShares lower the management fee on four ETFs. So it’s time to update the ETF cost comparison. Also, I am changing my initial recommendation on starting your investment with SmartShares then switch to SuperLife.

Cost update

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Both Superlife and SmartShares lower their cost on Total World, Europe, Asia Pacific and Emerging Markets ETF. The reason was Vanguard reduce their underlying fee, so SuperLife and SmartShares passed on the cost saving to its customer.

Should you start with SmartShare?

In the past, I recommended to start your ETF investment with SmartShares then switch to Superlife when the fund hit a certain amount. The main reason was Superlife charge a $12/year admin fee, it will cost more in term of percentage for beginners with a small amount of investment. However, that calculation ignored the $30 one-off initial fee, the cost of setting up extra funds with SmartShares and the exit cost.

Let’s look the following example for an investor started NZ Top 50 ETF with $500 initial investment and $50/month contribution for 5 years. NZ Top 50 ETF 5 years annualised return is 16.49%. I’ve put it in a simple simulation to compare investment between SuperLife and SmartSharesand for 5 years.

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SmartShaers started with $30 less due to the setup fee. That $30 initial different made Smartshares cost more for that first 3 years, (38 months to be exact). By the end of the 5 years, the different between Superlife and Smartshares is only $24.09. That’s about 2 years of SuperLife admin fees and represent about 0.44% of your holding. That percentage will decrease if we increase the investment amount. So, there are some saving with Smartshare, but the saving is insignificant.

Also, there are some other benefits with SuperLife.

  • Better user interface compare to Link Market Service
  • Easy to switch fund with no cost
  • No setup cost for new fund
  • More fund options included sector fund and passively managed fund
  • No withdrawal cost

Personally, I think those benefit worth that $12/year with Superlife.

My Recommendation

If you wish to invest in S&P500 ETF, NZ Cash ETF and Emerging Market ETF, start with SmartShares because their management fee is still lower than SuperLife.

For any other ETF, just go and join SuperLife. You will be much better off.

If you are currently holding SmartShares ETF and want to switch to SuperLife. There is a way to switch without open a brokage account and pay $30 to sell your Smartshare. However, you will have to email me on that.

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

Why your KiwiSaver Employer Contribution are Less than Yours while Both Paying 3%

By New Zealand law, the employer required to contribute to their employee’s KiwiSaver account or complying fund at 3% of their gross salary or wage if the employee joined Kiwisaver. However, when you look into your KiwiSaver contribution transaction record as an employee, you may notice the employer contribution amount are less than your employee contribution.

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Here is an example, assume your weekly income before tax is $1200, $62400/year.

Without KiwiSaver, your take home pay will be $1200 – 225.77 (PAYE) – 16.68 (ACC) = $957.55.

If you join KiwiSaver and contribute 3%, your take home pay will be $1200 – 225.77 (PAYE) – 16.68 (ACC) – 36 (KiwiSaver) = 921.55 On your KiwiSaver statement, your contribution will be $36. However, your employer contribution will be $25.2, not $36. Why?

The reason is the employer contribution are taxed under Employer superannuation contribution tax (ESCT). Your employer payout extra 3% of your income to KiwiSaver but part of that went to IRD as tax.

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You may think why both employer and employee are paying 3%, how come the cash hit my KiwiSaver fund is different? (That was me two days ago)

Let’s break it down in detail. The 3% contribution is calculated based on your income before tax. In our example, the weekly 3% KiwiSaver contribution will be $1200 x 3% = $36. So both employee and employer will pay $36 each into the KiwiSaver Fund.

Here is the tricky part, on employee contribution, it was calculate based on pre-tax income and take out on after-tax income. So the $36 will take out after they deduct PAYE and ACC and that $36 will reach your KiwiSaver fund without IRD take out any more tax.

On the other hand, employer contribution will be taxed under ESCT. So 30% of $36 = $10.80 will go to IRD, and the cash hit your KiwiSaver fund will be 36 – 10.8 = $25.2

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Therefore, I was wrong by saying you will have 100% return on your employer contribution. It’s more like 67%-89.5% return. It’s still an unbeatable risk-free guaranteed return and one of the best investment in New Zealand.

Check out IRD website on ESCT for more information.

P.S. Thanks to gligorkot for pointing that out on a previous blog post.

Simplicity Cease Offering on InvestNow… but Don’t Let it Stop You

Last Friday I wrote about investing Simplicity non-KiwiSaver fund via InvestNow from as little as $250.

However, I am sorry to say this opinion is no longer available. Simplicity decided to cease offering on InvestNow.

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You can read the statement from InvestNow here.

I am personally disappointed as this is a great way for anyone to invest in a quality low-cost fund with a low initial investment. I was planning to invest in Simplicity fund but I don’t have the fund until next month, so I missed out on that.

What does it mean for the investors?

If you are InvestNow user and you already invested your money into Simplicity fund via InvestNow, you will be able to hold your investment in the fund, but you will not be able to make new investment.

For those who wanted to join Simplicity Fund but don’t have $10k available, you will have to keep saving until you reach $10k…. or not. Hear me out!

Don’t wait, Start NOW!

If you have some money to invest now, you don’t have to wait. I would suggest you invest those fund elsewhere rather than save for months and years to reach $10K.

I know Simplicity fund is excellent, and I may even say it’s the best fund in this country. However, that is just the best fund when you have $10k or more. It doesn’t mean you can’t invest in anything else before you come up with $10K.

You can invest in Superlife 80, which is similar to Simplicity growth fund. Superlife 80 holds 80% growth asset (Share, property) and 20% income asset (Bond, cash). They also invested in Vanguard fund and ETF. Superlife a higher management fee (0.50%) and small annual fee ($12). The most important thing is there is no minimum initial investment requirement. If you are young and happy with the risk, you can go with Superlife 100, a managed fund with 100% growth asset, something Simplicity do not offer.

If you already put the money in InvestNow, you can invest in their Vanguard fund with just 0.26% fee. Simplicity Growth invested 60% into that fund (and you will have to pay tax on dividends received). I’ve done a blog post on that.

My point is, there are lots different opinion for investor out there. Don’t let that $10K hurdles stop you and start investing. You will reach $10k before you know it.

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Do you need KiwiSaver if you plan to retire early?

(This post contains the concept of  Financial Independence & Retire Early (FIRE), and terms like 4% withdrawal rate that may sound confusing. If you like to know more, jump to the end of this blog post for more information.)

When we approaching June in New Zealand, you can see lots of personal finance articles tell everyone to put in some money into their KiwiSaver and get the free money. I want to focus on a group of people who is working toward financial independence and wants to retire early. They may think since they are planning to retire way ahead of 65, KiwiSaver is irrelevant to them. They could be in KiwiSaver, but not sure if they should include KiwiSaver as part of their financial independence plan.

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Return on your KiwiSaver contribution

If you wish to live off your saving and investment, you ought to find the best return on investment out there. For KiwiSaver, your employer has to match your 3% contribution, and some employer may go higher. That’s 100% return on investment! (Correction: Actually is not 100% return because the employer needs to pay tax on their contribution. So the ROI is 100% – Tax, from 10.5%-33% less. Still a great return)

The government also provide KiwiSaver member tax credit for the first $1042.86 contribution from you each year (not counting your employer contribution). The Government will pay 50 cents for every dollar of member contribution annually up to a maximum payment of $521.43.  That’s 50% return on your first $1042.

If your wife/husband/partner is not working and you are working full time, you should consider contributing $1042 into their account as well. Those credits are risk-free and guaranteed.  It is hard to find such return on the market with basically no-risk.

Locked until 65

Some people think the big problem of KiwiSaver is you cannot access the fund until you turn 65 or to buy your first home. For the people who are planning an early retirement, they like to put every dollar into their investment so the investment can generate enough income to support their living expenses.  They don’t count on KiwiSaver and NZ superannuation to retire. However, you should still put money into your KiwiSaver.

One simple question: Do you plan to live beyond 65? If yes, then you should contribute to your KiwiSaver because it’s your money! You will spend on your investment before 65, and you will still spend on your investment after 65. The KiwiSaver fund is just one of your investment funds, and you don’t draw on that fund before 65, it will still help you to achieve your financial independence.

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Include KiwiSaver fund into your early retirement number

Look at the graph below. We assume you need 1 million portfolios to retire early, $300k in KiwiSaver and $700k in a normal investment fund. Your annual withdrawal rate 4%.Blank Diagram - Page 1(1).jpeg

You just need to stack up your investment and put KiwiSaver at the bottom and only draw the fund at the top. You keep drawing your non-KiwiSaver investment fund before you turn 65 and let your KiwiSaver Fund untouched. Yes, your non-Kiwisaver fund may get smaller and smaller (depends on your withdrawal rate) because you are drawing $40K (4% of 1 million) on a 700k investment fund. However, your KiwiSaver fund will keep growing. When you reach 65, you can draw from both funds.

Therefore, you should keep contributing to your KiwiSaver and include KiwiSaver as part of your early retirement plan.

Don’t over contribute into KiwiSaver

The key is you should not put too much into your KiwiSaver. You don’t want your non-KiwiSaver fund run out of money before you reach 65. Although it’s unlikely but possible.

Let’s assume you are 40 years old and have 1 million investment portfolio. You plan to draw 4% on your investment every year for living expenses. The expected return on investment is 6%. However, for some unknown reason, 70% of your investment are in KiwiSaver, and only 30% of your investment are in non-KiwiSaver Fund. You can only draw from your non-KiwiSaver fund before you turn 65.

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By age 48, your total portfolio growth to 1.24 million but your non-KiwiSaver fund ran out. Most of your money are locked in KiwiSaver, and you are 17 years away to access them. You need to go back to work.

To avoid that, you just simply contribute up to wherever your employer will match and enough to get the member tax credit every year. Put all extra cash into your non-KiwiSaver investment, including paying off mortgage, shares, bond, property, etc.

Now, if we reverse that situation and put 30% investment in KiwiSaver, 70% in non-KiwiSaver. That non-KiwiSaver fund will least 30 years. Here is the how the fund works.

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How long will you non-KiwiSaver fund least?

I actually worked out the formula on how many years your non-KiwiSaver fund will least base on percentage of your portfolio in KiwiSaver. The graph was based on 4% withdraw rate. KS empty at 4.png

X is the percentage of your KiwiSaver and Y is the number of years will your non-KiwiSaver fund last.

If your Kiwisaver is about 18% of your total investment and you are 28, do you need to worry? Using that formula y = -24.61(0.18) + 0.3429, y =42.5. Your Non-Kiwisaver fund will least 42.5 years, by the time your non-KiwiSaver fund runs out, you are already 70 years old.

If you plan to retire at age 38, you will have to draw on your non-KiwiSaver fund for 27 years. Using that formula 27 = -24.61 In(x) + 0.3429, x = 33.85%. So your KiwiSaver needs to be less than 33.85% of your total investment portfolio.

That formula only works with 4% withdraw rate. You can work out how long will your non-KiwiSaver fund least with your own figure. Check out this google sheets. Make a copy and play around.

Conclusion

  • KiwiSaver is a great investment with a high return on investment due to employer match and government tax credit. It is one of the best investment in New Zealand.
  • You should contribute toward your KiwiSaver to achieve Finacial independence and include your KiwiSaver amount into your equation.
  • Do not over contribute into your KiwiSaver.
  • If you are employed, you should contribute up to your employer match and no more.
  • If you are self- employed, just put in $1042.86 to get your $521.43 tax credit every year.
  • All extra cash goes into non-KiwiSaver investment.
  • If you are not retiring extremely early (in your 20s) and your KiwiSaver is below 20% of your total investment portfolio, you will be alright.

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About FIRE

If you want to know more about Financial Independence & Retire Early, I will cover that in the future. Meanwhile, Check out the link below.

What is Financial Independence & Retire Early (FIRE)

The Shockingly Simple Math Behind Early Retirement

The 4% Rule: The Easy Answer to “How Much Do I Need for Retirement?”

Kiwi Mustachians – New Zealand FIRE community (Facebook Group)

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

Investnow – Invest in Vanguard Fund with 0.20% Fee

Investnow is a new online investment platform and fund management service just started this year in New Zealand. It is NOT an investment firm but a marketplace for investment funds. Kiwi investor can directly invest into the selected fund on investnow platform without the middle man. I’ve done some research on the company and invested some money via the service. Here are my findings.
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Range of Fund

Investnow offers 33 different investment funds from both local and international fund manager. The investor needs to deposit minimum $1000 $250 into Investnow transaction account and invest into the fund on their platform at $250 minimum.
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Here is the list of the fund provider
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No Transaction/Admin/Joining/Setup/Exit Fee

The main selling point for Investnow is no transaction/admin/Joining/Setup/Exit fee at all. When you put $1000 $250 into Investnow, Investnow won’t charge anything on your money. You can invest that full $1000 $250 into different funds. You only need to pay the cost of each investment fund.
Investnow made their profit by charging investment fund providers to list their funds on their platform.

The REAL selling point

Since investor can contact most of those investment funds directly and set up an account, no transaction/admin fee is not a real selling point here. For me, the real selling point for Investnow is low barriers to entry and Vanguard fund.
If you want to invest into those funds directly without Investnow, the majority of those funds have a minimum initial investment amount from $2000 to $500000. For example, Fisher Fund’s International Growth fund require minimum $2000 initial investment and Mint asset management’s Australia New Zealand Real Estate Investment Trust minimum investment is $5000. If you invest from investnow platform, you can put only $250 into those funds. It dramatically lowers the entry requirement for those funds and makes it more accessible to the average retail investor.

Vanguard fund

Vanguard

The most significant benefit with investnow (for me at least) is you got access to Vanguard International Shares Select Exclusions Index Fund. That fund launched for AUS and NZ market in late 2016. It contains about 1500 listed companies across 20 developed international markets (without Australia). This fund is an ethical fund as they excluded Tobacco, controversial weapons and nuclear weapons investment.
Simplicity Kiwisaver invests heavily into this Vanguard fund. 61% of Simplicity Growth fund invested in Vanguard International Shares Select Exclusions Index Fund.
There are two versions of this fund. Vanguard International Shares Select Exclusions Index Fund has a low managed fee at 0.20%. The Fund is exposed to the fluctuating values of foreign currencies, as there will not be any hedging of foreign currencies to the Australian dollar. So this fund has a higher risk due to foreign exchange fluctuation. Vanguard International Shares Select Exclusions Index Fund – NZD Hedged are hedged in New Zealand Dollar with a higher management fee at 0.26% but with lower risk.
For individual investors, if you want to invest into this fund directly, you will have to start with $500,000 AUD. Investnow lower that entry barrier down to just $250. In my opinion, this is a great fund to invest because of the low-cost, diversified portfolio and low barriers to entry.

Everything sounds good, so what’s the catch?

Yes, there one thing not so good about Investnow. You’d need to do your tax return if you invested in Vanguard funds.
Admittedly, I am not good at tax. So the following information may be wrong.
From what I understand, those two Vanguard funds are not the same with other listed fund on their platform as they are not PIEs fund. Vanguard funds are Australian Unit Trusts. Accordingly, they are taxed under the FIF rules (that apply to global shares). Investors need to do their own tax return. Investnow produces consolidated tax information to help investors to complete their own FIF tax return.

My Experience

After some research and background check on the company, I invested $1000 into Investnow and tested it out.
The sign-up process was quite simple; I managed to complete in 5 mins. The interface is easy to understand. The funding and investing took 1-2 days to complete. You can check out your holding and performance any time.
Check out the screenshots below. 
 
One thing worth mentioning is Investnow use a Two-Factor Authentication for login. You need your username, password and a six-digit passcode that send to your email or phone to log in. I recommend using your phone to received that passcode in txt.

Conclusion

So far I am happy with the Investnow as its allow me to access Vanguard fund with just $1000 $250 investment AND no one charging me extra fees in the middle. The service is straightforward and easy to use. The only concern will be the tax implications on its investor if you invest in the Vanguard fund. (Personally, I need to figure that out before next April.)
InvestNow is free to join. You don’t have to deposit $250 to become a user. You can just sign up with an email address and check out the offering.
Investnow is a new company; some investor will (and they should) question the legitimacy of the company/service and the safety of their investment. I’ve done research on that and I will share that in the next post.
(UPDATE: InvestNow recently lower their minimum deposit amount to just $250.)
Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.