RunningMoney

THE SUPER BIG DIPPER*

13 April 2017

I was interviewed on ABC Breakfast yesterday (in case you missed it, the video link is at the bottom of the article) and the theme of the day was Scott Morrison’s support of “super dipping”. It’s generated a huge amount of interest as politicians from both parties, and from the past, state their support or otherwise. Concerned that my political nouse, or complete lack thereof, would soon become apparent, I was relieved when the producer told me that they were all over the political aspects. They just wanted someone to cover the economic issues, which surprisingly very few had actually looked at…apart from headline-grabbing one-liners.

So to save you from watching the video (well you can still do that if you want to, but the facts are all covered here), this is a summary of how the Marcus Today team views the plans.

WHAT EXACTLY IS BEING PROPOSED?

The concept of using superannuation savings to help fund the purchase of major assets such as a first home is not new. The idea was first floated in 1993, just a year after compulsory superannuation was first introduced, but fortunately Paul Keating snuffed it out pretty quickly. It resurfaced in a major way in 2015 based on suggestions from the Committee for Economic Development.

In the supporters’ camp, we have Treasurer Scott Morrison and Assistant Treasurer Michael Sukkar, while former Prime Minister Tony Abbot is a supporter along with former treasurer Joe Hockey.

The critics include Prime Minister Malcolm Turnbull, Finance Minister Mathias Cormann and Financial Services Minister Kelly O’Dwyer.

In its current form, the proposal would allow young Australians (an age limit would apply for accessing the scheme but that hasn’t been settled in the current proposal) to divert their compulsory super payments into a special “housing deposit” account.

They could do this for up to three years, and they would have to match the amounts from super, dollar for dollar, with their own after-tax deposits.

As an example, assume Mary is 27 years old and earns $75,000 a year. Her annual compulsory superannuation contributions are $6056.25 after the 15% contributions tax. Assuming quarterly contributions paid in arrears and an interest rate of 3% paid on the account balance, the value of these super contributions, PLUS her own dollar-for-dollar after tax contribution, will be $37,875 after 3 years. She will be 30 years old and able to use this $37,875 towards a deposit for a new home.

Some alternative salary scenarios are show in the table above but the first observation I would make is that $37,875 is not going to put much of a dent into the price of any house or apartment within coo-ee of our family home. Unless there is someone or something else propping up that deposit, a visit with my kids will involve a bit of long-distance travel. Of course, that may well be a good thing…but you get the picture.

WHAT’S THE POINT?

The basis of the super dipping proposal is that access to this extra pool of funds will give new home buyers an advantage when trying to buy their first home. They’ll have more funds to put toward a deposit. The government is trying to find ways to resolve the housing affordability crisis.

This will not resolve the housing affordability crisis.

But while there is no doubt that the proposal will help first home buyers save for a deposit, it doesn’t actually do much to improve the affordability of housing. If fact, it works in the opposite way.

My high school economics teacher Mr Delaney would be very proud that I still remember some of the basics from his classes in Keynesian economics. If demand for a product or service increases without a corresponding increase in supply, the price will go up. It’s a really simple concept.

If there is no supply response (i.e., more houses built), this proposal simply gives first home buyers extra money to play with at auction time. With more money in the pocket and a higher budget, there will be more competition and house prices will be bid higher.

Mary won’t be better off – she will just have spent $37,875 more on the deposit (not to mention the value of the house) than she would have paid previously. The only winners under the scenario are those of us who already own (some) of our house.

This reduces confidence in the superannuation system.

All types of markets and systems require “confidence” in order to survive. A loss of confidence in the banks, for example, results in a rush on deposits and ultimately a failure of the banking system. While not quite so dramatic, the constant changes to the rules and regulations surrounding superannuation simply undermine the confidence in the system, creating confusion.

We work with a bunch or super-smart financial planners in this office and keeping on top of all the new rules and regulation changes around super, to give our clients the best advice, is a huge effort. I can’t imagine how hard it must be for the less financially sophisticated, particularly those not yet close to retirement. Putting it off because “it’s all too hard and the rules will probably change anyway” is a comment we hear quite a bit.

The super dip proposal does just that. It undermines the sanctity of retirement saving. If we can tap into our super for buying a house, where do we draw the line? If a redundancy means we are having issues paying the mortgage, can we dip in then? If we have a medical issue, can we dip in then? Private school education? Helping the kids finance their own housing purchase? While there are hardship rules built into the current superannuation system, they are fairly strict and are not easily applied. A deposit for a house clouds the issue about what constitutes a valid reason for accessing retirement savings for one person versus another.

The magic of compound interest

No financial analysis would be complete without a demonstration of the beauty and magic that is compound interest. Using our previous example, Mary was 27 years old when she started putting her super into the special “housing deposit” account. Fast forward 3 years and she is now 30 years old with $37,875 extra in her pocket at auction. But imagine that instead of utilising the housing account, she left the (now) $18,937 in her superannuation fund

If Mary’s super fund achieves an average annual return of 5% for the 30 years until her retirement at age 60, and that is a very modest assumption considering the major banks yield at least 7% including franking without any capital appreciation, that $18,937 would become $81,846. A more reasonable 8% return and the value becomes $190,559. And if Mary’s super fund can achieve an average annual return of 10%, the opportunity cost of using those 3 years’ worth of contributions to fund a more expensive house has grown to be a loss of $300,444 in retirement savings. This doesn’t even allow for the dollar-for-dollar matched after-tax contributions. If Mary had decided to salary sacrifice these or make after-tax super contributions, we can double these figures. That is the power of compound interest.

IT’S ALL ABOUT THE TIMING

I’ve heard some financial planners use an expression “It’s not about timing the market, it’s about the time in the market”. I have mixed feelings about this saying, and I suspect it’s often an excuse for not keeping a close eye on a client’s investments. In the case of the proposed super dip, timing is definitely one of the key issues.

The last few weeks have been dominated by headlines about risky bank lending, including new regulations from APRA to reign in interest-only loans and improve lending practices, strong words from the RBA about the levels of household debt, housing prices and bank lending, and proposed reforms from ASIC.

Just today, in its Financial Stability Review, the RBA has issued another strong warning about the surge in household debt and the rise in interest only loans. In this review, instead of taking comfort from figures that on average households are 17% ahead on their mortgages, the RBA notes the variance. “…one third of borrowers have either no accrued buffer or a buffer of less than one month’s repayments. Those with minimal buffers tend to have newer mortgages, or to be lower income or lower-wealth households.” The RBA suggest this could exaggerate the economic impact of a housing cycle downturn, and “amplyify the size of a subsequent downsizing in housing prices”

So far the banks are going along with the troika, saying the tougher rules from APRA will lower the need for higher interest rates in the long term and that is good for the health of the economy and the housing market overall. And of course themselves. The frog is in the pot and notes the rising temperature, commenting on how it has made things less chilly. Hmmm.

Apart from ignoring the obvious, the banks have started raising interest rates, independently of the RBA. The increases are targeted at interest-only and fixed rate mortgages…but it’s the start.

I’m not sure anyone under 40 even knows what it feels like to see their mortgage repayments go up. But it’s a game changer. For those young “investors” who have used the equity in their first investment property to finance the deposit on the second, etc. etc., a strategy which is sold in any number of property investment “seminars”, these investments may well become “houses of cards” as interest rates rise and the banks crack down on higher risk loans.

I’m not saying there’s a risk of a housing crisis like we saw in the US. For starters, in Australia we don’t have an option of handing in the keys and walking away from the house and the mortgage like US homeowners do. So when the going gets tough, most Aussies will tough it out. They’ll renovate, paint a few walls, tart up the furniture and make do. There is also a huge amount of pent up demand just waiting for prices to ease before stepping in to pick up the slack. Three houses for the kids within a 10km radius of the family home in Elwood would be nice, at the right price, thanks very much.

So while there might not necessarily be a huge housing market collapse, the returns going forward are probably going to be less than exciting, and will almost certainly not match the returns that Mary could achieve in the tax-effective superannuation environment. It’s probably best to leave it there.

SO WHAT TO DO

At a National Press Club luncheon yesterday, Deloitte Access Economics economist Chris Richardson gave his advice to young Australians, saying “don’t buy” and that in the current market “let’s not forget that rents today make a lot more sense than housing prices.”

His comments reflect those of the Luci Ellis, the RBA’s head of economics, who says that declining rates of home ownership aren’t necessarily a bad thing and often reflect a delay in settling down and buying a home. She argued renting would be a more attractive option if housing security was improved. “If we are concerned about inequality of housing outcomes, perhaps we should focus less on the type of tenure, and more on security of tenure.”

And while it does give a wake-up call to the Aussie dream of owning your own home, Ms Ellis has a very strong point. As long as security of tenure is not an issue, it may be a much more attractive financial solution to rent and invest in super and other growth assets, rather than invest in a stagnant property market.

Which brings us to the political debate and shifting focus to the issue of housing investors being favoured at the expense of home buyers. Negative gearing anyone? And that’s a topic for another day.

AND THE LESSON IS

As existing home owners, many of us have benefited from the rise in property prices and the resulting “home ATM” provided by our increasing equity. Unless we have kids whose future residence is continually challenging our GPS capability, the topic may not be as hot as the property market.

But if you take nothing else from today’s EDUCATION, take with you the power of compound interest. The importance of saving early for retirement should not be underestimated. It’s really important to save as much as possible, as early as possible…smashed avocado, while undeniably delicious and nutritious, won’t fund your retirement. Tell your children, tell your grandchildren.

As an end note, while looking at some of the commentary and press on this issue, I came across an interview with Dr David Knox from Mercer, who was Professor of Actuarial Studies at Macquarie University when I was a student there, as well as my lecturer for the subject “Advanced Mathematics of Finance” (or ADMOF as it was affectionately known) in 1988.

David is Australia’s leading expert on superannuation and was talking about the system in Singapore, where superannuation is used to fund retirement, healthcare and housing (the fund is split into 3 accounts). David points out that in Singapore, superannuation contributions are much higher at 30% and the scheme is specifically designed with a housing objective, so it’s not necessarily a valid comparison. I have used some of the mathematical principles Professor Knox taught me in my university years, and which are in his textbook (pictured), for the purposes of this article. While the equipment has clearly changed, the maths and the magic of compound interest have not.

Click here to access the video.

*This article first appeared on the Marcus Today website