Agony Aunt: Does $500,000 make you rich?

Dear Janine,

We are a couple who have recently inherited $250,000 to $500,000 (not quite sure yet!). We are renting and one of us has a stable, pretty good income and is happy to remain at that job (maybe reduce to four days instead of five). We still have $60,000 in student loans and owe $7000 on credit cards. We could buy an investment property, which we'll live in, but aim for the mortgage to be less than the rent we pay now. I want to make sure we have enough liquid money for any unforeseen payouts and savings for our children's education in 12 years or so (we have three kids). Plus we want to have some fun now! We are confused about how to make the most of this money, as we want security for our future. Cash-rich but confused

ANSWER:

Inheritances remind me of the search light which has appeared from the broken Cathedral in Christchurch; it arrives like a ray of hope, but it's tainted with sadness, because money doesn't appear without someone departing.

That light is also a little bit spooky and an inheritance will always have that facet to it as well. There is an opportunity to reshape your life, but it comes with a big sense of responsibility. Someone close to you worked very hard for the money and it would be nice to make them proud of how you are spending it. I'm sure they would smile when you have a little bit of fun too.

Feeling flush with half a million?

You sound grounded and sensible and I can tell the sense of responsibility is not lost on you.

Just out of interest - have a think about this question. Does half a million dollars make you feel rich? It reminds you of Big Wednesday, but try and wipe the Q7 and the Gallardo from your mind. Lots of people would shout "I'm rich" from the roof tops, but I've got the opposite view. Half a million doesn't make you wealthy enough to be frivolous with a single cent of it. It's only enough to give you a basic foundation to build on.

You are a single-income family of five, who don't own their own home and have $67,000 in debt. This is going to sound harsh, but the money is only enough to leverage you out of a hole. This level of bluntness is intended to make you think. You are pondering a four-day week, but I don't think the size of the windfall gives cause to embark down this path. Especially since your current asset base is not just zero, but negative.

When you are starting below the low-tide mark and you need a home, a retirement fund, an education fund, and a summer holiday, you'll find the cash gets snaffled away very quickly. The groceries still need to be paid for and a growing family is going to chomp through your income. Part-timers struggle to get pay rises and promotion, so that decision could end up being a life-long hand- brake.

Sit and look at the money

When it arrives, think about sticking the money in a term deposit for a few months and not spending a cent. Just learn to live with it and look at it for a wee while. It's so easy to whip off to the islands in the school holidays and a promise to do a financial plan when you get back. Do it before you step on the plane or it won't happen.

Your "money personality"

You've got some hard decisions on how to carve up the cake, so your first appointment should be with a financial adviser. They will challenge you. Before you go, see if you can both agree the "non- negotiables". For example, does "fun" mean a trip to Te Papa in Wellington or the Tate in London? The cost implications are wildly different, but they might be dreams which are not up for debate in your family.

An adviser will take you through the steps: pay off debt, set aside emergency funds and decide on the priorities between owning a home, investing for retirement and setting up an education fund and Kiwisavers for your kids. Repaying the student loan will be debatable as it's interest free, so you may wish to invest that money instead. Crucially, you also need a savings plan for part of your wages. Remember, this windfall is just the foundation.

The big question is whether you take on a mortgage and invest some of the inheritance, or have no borrowings. There's a generic rule that it's unwise to borrow from one pot and invest in another (you can end up paying more interest than you earn). I don't disagree with this on a financial level, but it doesn't work for many people on a psychological level. If someone is mortgage free, but has to save each month into an education fund, it can easily get frittered away on flat-screen TVs and new clothes. The education fund never builds. If money is locked-up in advance in a long-term investment and they pay off a mortgage, the budgeting is more controlled. You have to seriously consider what type of "money personality" you are.

Home sweet home

Question yourself. Do you really want to start by owning a property that is selected for its investment potential and not for the needs of your own family? You need a permanent roof over your head - why not put yourself first? You could get used to being a home owner and then decide if an investment property is on the agenda further down the track.

Kicking the numbers around

With the help of an adviser, it is fun to kick the numbers around and discover the power of investing money. While the markets are an awful mess right now, and real returns are fairly paltry, it's not generally like that over the longer term. Just as a taster in terms of retirement planning: if $50,000 is invested today for 30 years and it achieves a 4 per cent return each year after tax, it will grow to over $160,000. With more risk and an 8 per cent return after tax, it could grow to over $500,000. Take off three decades of inflation at 2 per cent and that half a million will buy roughly what $300,000 does today. You have to admit those numbers are powerful and will make you want to plan now.

Janine Starks is a financial commentator with expertise in banking, personal finance and funds management. Opinions in this column represent her personal views. They are general in nature and are not a recommendation, opinion or guidance to any individuals in relation to acquiring or disposing of a financial product. Readers should not rely on these opinions and should always seek specific independent financial advice appropriate to their own individual circumstances.