One positive of higher interest rates is higher savings rates, as banks now pay healthy rates to savers with balances in things like savings accounts or term deposits. A good chunk of the banks’ mortgage funding comes from these types of accounts, which have been steadily rising over the past few years.
This brings a very good question – should I be saving, paying off debt or investing in things like ETF’s, shares or managed funds? I look at this below, which obviously has a lot to do with your unique situation and cashflow.
Cash is certainly king when it comes to personal finance, particularly in a recession like we are currently experiencing. The first step to any healthy financial stability is to have a strong emergency fund which can be used as a buffer if needed. I would always recommend a minimum of 6-12 months of expenses on hand, which should be your priority. This serves as an insurance policy if you were to lose income or face a medical emergency for example. If you have debt such as credit cards or a mortgage, these should be paid off as fast as possible, but sometimes keeping savings on hand provides more flexibility and peace of mind then eliminating interest paid completely. Most banks now offer offset of revolving credit facilities, which are the best of both worlds – they allow you to build an emergency fund while also reducing the interest you pay on your home loan. The best part – you still have access to the funds when needed.
Credit card, personal loan or asset finance debt can also be rolled into your mortgage, to consolidate the repayments and likely achieve a lower interest rate with more manageable terms.
Once your emergency fund is built, either in an offset/revolving credit facility or a high yield savings account (the former is slightly better as you do not pay tax on interest earned, but offset mortgage rates which are even higher than savings rates) you should consider investing spare cashflow where possible. Extra repayments on your mortgage can shave off years of interest and free up cashflow sooner, allowing more free cash flow for investments and lifestyle.
Dripping small amounts of cash into the stock market over time is known as ‘Dollar Cost Averaging’ and can be a powerful wealth builder long term. Many stocks also pay dividends, which can be reinvested into the market to buy more units or shares, creating a snowball effect.
Most of us have seen the power of compounding interest through KiwiSaver or index funds tracking the stock market or similar. The S&P 500 index in the United States has achieved an 11.88% compounded return from 1957 to 2021 - truly the eighth wonder of the world according to famed investor Warren Buffett.
We are beginning to see some great options for purchasing shares, indexes and similar popping up in New Zealand – this is exciting as it provides much needed competition to benefit the consumer. Managed funds are a good option as well if you prefer active management and want to achieve a specific outcome.
Artificial Intelligence tools like Bard or ChatGPT can also help educate you on different investment options and compare their metrics in a simplified way as well.