I discussed this on Breakfast Business on Newstalk on February 17th 2015. skip forward to just after the news, sport and papers
A few weeks ago the central bank moved the goalposts and now if you want to buy a house you have to come up with a considerably larger deposit than what was required before. This has got people thinking, what is the best way of saving long term?
This piece focuses specifically on saving for a deposit but a lot of what’s discussed here applies to any type of long term saving whether that’s saving for a house, funding kids college or saving for some other long term goal. We also have some specific advice for parents of children who are saving for a house.
The reality of the new rules is that the average house in Dublin now costs about €300,000 with Houses in Galway and Cork about €125,000 less than that. Wherever you want to buy you are looking at a deposit of between €40,000 and €60,000 (Dublin) as a first time buyer. So the reality is you need to start saving if you want to buy a house.
Now if we take an average wage, because you hope an average house can be bought by an average earner, the average person earns €2905 per month
A couple earning an average wage will take home about €4666 per month after tax. Applying mortgage criteria to their wage they should be able to use about 35% of their income to service their savings and their rent.
So a couple paying €1000 per month in rent would have €633 per month left over to save for a deposit. If they are buying in Dublin and they save in a bank account getting 1% interest (net) it will take them 92 months to reach their goal. 62 months in Galway or Cork.
Let’s think about that poor couple for a minute, they will be saving for almost seven and a half years to get a deposit together and we are ignoring house prices going up in the meantime! Seven and a half years.
So how can they do this smarter? They need to look at alternative options to saving in their bank account.
Investing in a well-diversified portfolio does mean turning up the volume in relation to risk. People should be wary of risk but not scared. Getting some good financial advice will help you decide what level of risk you are comfortable with.
When you are investing for time periods of 5 years plus what people often don’t realise is that you are guaranteed to lose money in a bank account. This is because at the moment bank accounts are unlikely to give you a return above inflation. So your choice is “guaranteed to lose money” on deposit or “possibly lose money” with a well-constructed diversified savings plan. But how big is the possibly?
Prosperous has model portfolios. If you invested a lump sum for 5 years in one of our more cautious portfolios anytime between 1990-2014 there was no 5 year period where you would have lost money during that time using our Prosperous 3 portfolio. Yet the annualized return in the past 25 years was 7.83%.
Now this is the interesting bit, those figures are based on lump sums. However a lump sum is invested on a particular day and taken out on a particular day. When you are investing regularly like when you take out a savings plan you significantly reduce the risk you are taking. This is as a result of what’s called “euro cost averaging”
In simple terms what I am saying is that when you save on a regular basis into a well-constructed portfolio of shares, bonds, property, commodities and cash you are dramatically reducing your risk of a negative result.
But what are the rewards? You could save nearly €9000 in savings contributions and knock well over a year off how long you will need to save for. That’s if you managed to achieve your 6% net growth per annum in your well-constructed, well diversified portfolio.
But what do you need to look out for? Charges are a key factor. Some savings plans of this nature on the market have such outrageous charges that you would have been better off in a bank account. Look for things such as ongoing charges, policy fee’s and allocation rates.
If you are a parent considering helping out your child, think again. Revenue recently issued a paper on what were acceptable transfers to children and I don’t think giving them a deposit for a house is an accepted “cost of raising your child”.
But parents you can be cute about this, two weeks ago with Bobby Kerr on Newatalk we discussed inheritance and gift tax and the astute listener will recall the ability to gift €3000 per year per child into a savings plan without reducing your gift tax threshold. This is ideal for this. If you were really keen and had the cost of college boxed off it may be a way of gifting your now one year old their deposit for their house in 20 years’ time.
The reality of these changes is they are now in. They may change in the future but for now we have to just deal with them. Buying a house is no longer as easy as reaching 25 and swapping the restaurant for a take away or the pint for a can. Long term financial planning is now required and from a much younger age. The next generation will have the home owners and the renters, you decide.
Net tax calc