Investing in equities or tracking a particular stock market index - Limerick financial planner

Question
Liam, I have two kids aged eight and five and I was thinking of trying to invest in a stock market index that tracks for example the S&P 500. I have an online trading account which I use for some small investments that I make for myself but I would like to try and use the power of compounding interest over the next 15-20 years for their benefit and to show and teach them as well. Any thoughts on this and is my thinking right?

Answer
Investing in equities or tracking a particular stock market index is certainly the way to go when investing for the time period you suggested, especially if you want to take advantage of compound interest.
And that’s because the returns are usually much greater than what you would get if you deposited funds into a bank account.
You mentioned the S&P 500 and for the last 10 years it has averaged a gain of about 10.56% annually and when you account for inflation the real return is closer to 8.56%.

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So, if you invested for example €5,000 10 years ago it would now be worth about €11,732.93 where the interest in year 1 would be €445.20, year 2 €484.84, year 3 €528.01, year 4 €575.02, year 5 €626.22, year 6 €681.98, year 7 €742.70, year 8 €808.83, year 9 €880.85 and year 10 €959.28.
And that's the power of compound interest where you are getting interest on your interest.
It’s the same €5,000 you started with but the interest increases every year because the interest is being added to the account all the time.
If the interest rate you get was say 1.5% per annum, then after 10 years your €5,000 would only become €5,808.63, so what am I saying, I'm saying the account you invest into matters but you know that.
And I think doing this and being able to show your kids how important it is to save consistently alongside saving into the right account is a great financial lesson you could show them and it’s something that they will absorb and take with them and use for the rest of their lives.

Question
Hi Liam, I'm a 23 year old lad looking to get a start on the property ladder. I just wanted to ask you about a mortgage for a property I'm buying soon. My income with shift allowance is €85,075. I was looking at getting a mortgage of €90,000 over a 10 year term and if I did I’m told my monthly repayments would come in €917,11 (based on a 4.15% variable interest rate ) and €889.46 fixed for five years. The property value is €140,000. Have you any suggestions on anything which will benefit me and help me get that time down on repayments? I know fixed is probably better for a big mortgage and all but for this case would variable be good as I'm in a good position to overpay the repayments as often as possible. Any advice appreciated.

Answer
The ability to overpay on a mortgage when you have a variable rate is unrestricted i.e. you can overpay as much as you want without penalty, whereas with a fixed rate you are limited by the amount depending on the lender.
The issue with a variable rate is that rates could go up or down for that matter so you don't have any certainty with what you monthly repayment will be whereas you do with a fixed rate for the fixed time period chosen.
So, in instances like this my advice would be to consider a split mortgage i.e. have part fixed and part variable.
Your mortgage doesn't have to be one or the other and by doing this you are (a) creating the ability to overpay without penalty on the variable portion and if rates went up the impact isn't as big as if everything was in a variable rate and (b) you are benefiting from having a portion of your mortgage fixed and the certainty that gives you.
With your new mortgage perhaps think about fixing 50% at a variable rate and 50% on a fixed rate.
Because if you did, you could make overpayments on the variable portion and if for example you overpaid by say €2,000 each year you'd reduce the term on the variable portion by three years which means your mortgage would be cleared in seven.
Or you could make monthly overpayments of €200 and if you did, you'd reduce the term by three years five months and in that instance your mortgage would be gone in six years seven months.
These are just two examples of the impact making those overpayments would have on your new mortgage and all the while you have the security and certainty of having 50% of it fixed as well.
Something to consider.

Question
Liam, I’m 40 years old and I’ve just moved job and I’m not sure whether I should take the pension I’ve accumulated with me to another employer or leave it where it is or put it into a Personal Retirement Bond. A financial adviser working for the company’s pension scheme I’ve just left told me to leave it where it is because the fund has performed well but I’m not sure I trust him as there appears to be an obvious conflict of interest. What are your thoughts?

Answer
Reader: Before I tell you what my answer to him was, there was some back and forth between me and him as I needed to get details of his existing fund, what it was invested in, what was the value, what the charges were, what is personal appetite for risk was, what other sources of income he had, what his new pension was going to be and what he and his new employer were going to contribute, when he wanted to retire etc.
So, I couldn’t give him advice just based on his initial question, I had to dig a little deeper and get more information from him so I could give him the best advice and when I did, this was my response.
Your existing fund which has a risk rating of five has done very well and over the past five years had annual returns which averaged 16.67%, which was excellent.

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I looked at other funds available and I did so based on exactly the same criteria as to the fund you have in place i.e. same risk rating, same geographic spread, exactly the same management charge etc. and I found one fund that was performing slightly better than your existing one and I mean slightly better because over the past five years, its average return was 17.37% which was 0.70% greater each year than the fund you were invested in.
And some might discount 0.70% as being very small and wouldn’t make a material difference but I’d say think again because when I ran the numbers for you, it tells a different tale.
Because when you look at the difference between earning 16.67% and 17.37% each year over the next 10 years on the size of your fund which you’ve told me is €351,783, you would uncover the following four numbers:
€131,618
That’s how much more would be in your fund with a 0.70% higher annual return
€32,905
That’s how much more you’d get in tax free cash from getting that 0.70% higher annual return
€98,714
That’s how much more would go into your pension fund after taking out the tax free cash from getting that 0.70% higher annual return
€3,948
That’s how much more your pension would pay you each year in retirement from getting that 0.70% higher annual return
Of course the differential between these funds may not always be 0.70% per year and the annual returns may not always be as high as they’ve been in recent years and I’m sure they won’t be because you will de-risk your fund as you get closer to retirement older but my point is that returns matter and what might look minimal could actually turn out to be huge so never discount what might look like a small difference and never take advisers word for granted either especially when you’re right there does appear to be an obvious conflict of interest i.e. are they working for you or are they working for the company you left and if they are being paid by the company rather than you, well that answers your question really, doesn’t it.
Anyway, I hope this helps.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie or www.harmonics.ie