Paying Down Debt vs Saving and Investing

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The question of whether to focus on paying down debt or to prioritise saving and investing is one that many people wrestle with. Like most trade-offs there are several variables to consider, so let’s see if we can simplify this into some workable strategies.

Firstly, you cannot come to a conclusion unless you have a handle on your budget. Getting clear on your income and expenditure is the first step. That way you will know exactly how much you have left at the end of the month to allocate.

The next thing is to make sure you have some basic financial security. If you don’t have any savings it is perhaps prudent to pay off the minimum on your debt until you can build up an emergency cash reserve. Aim for a minimum of three months expenses so you have some breathing space if you lose your current source of income.

Obviously you want to try to pay off any high interest debt first. Credit cards are the number one offender here. With APR often as high as 18% it is wise to clear this as quickly as possible.

Student loans often come next. For people who studied in the US for example, student loan interest rates seem to be around 6-7%. If you are thinking of investing the money to get a better return and pay off the debt later, this is not an easy hurdle to clear without taking a lot of risk.

Where the trade-off question gets interesting is with home loans, particularly for people living in Japan with floating interest rates below 1%. There’s a strong argument for making your minimum monthly payments and saving and investing everything you can. I certainly wouldn’t disagree with that, but everyone feels differently about debt. I know people who never bought their own home because they couldn’t stand the idea of owing the bank that much money. If it keeps you awake at night, there’s nothing wrong with paying off your mortgage as fast as you can.

Once again, it’s good to make sure you are clear on your budget. Then make sure you have an emergency cash reserve, and have protected yourself in case you get sick or injured and are unable to work. In Japan you are required to buy life insurance to cover the loan in case of death, but in other countries you may need to consider this yourself. Paying into some kind of pension plan counts as one of the basics too and I would prioritise that over paying down debt. In his book Rich Dad Poor Dad: What The Rich Teach Their Kids About Money That the Poor and Middle Class Do Not!, Robert Kiyosaki talks about the concept of paying yourself first – make sure you are saving and investing for your future before paying the bank back more than you have to.

That said, if you are hitting your targets for saving and investing, then paying down debt is certainly not a bad thing. It reduces the amount of interest you will need to pay over time and the number of years it will take to repay the loan. Even 1% per year adds up!

For people in Japan, here’s an unexpected bonus: In order to get a mortgage in Japan you are required to appoint a guarantor. For expats this usually means paying a loan guarantor company, and you pay them up front when the loan is arranged. If you make ad-hoc lump sum payments to reduce the debt, the guarantor’s liability is reduced and they actually pay you back some of their guarantor fee. We recently made a payment of ¥1,000,000 on our home loan and received almost ¥60,000 back from the guarantor.

So to summarise, cover the basics first, prioritise high interest debt, and make sure you are saving and investing for the future whilst paying off the rest.

 

 

 

The Lifelong Expat

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So you’re a lifer? Congratulations! For some people expat life is so good, they never intend to go home. Also of course, many people make their lives in their country of choice: they have a home, family, kids in school, perhaps a business, things that they never plan to leave behind to “return home”.

So, sticking with Japan as our example, how should you adjust your planning if you are staying here for life? Many of the basics do not change, but everything will have more of a Japan focus. We will look at each of these in more detail later but here is a summary of things to consider for now:

  • Protection – this is of course the first place to start. See the protection review here for the basics. This probably means taking care of some of your insurance needs with a Japanese insurance policy, which of course means policy documents and explanations in Japanese. It’s worth looking around for a local insurance agent you can communicate well with, and exploring hospitalisation insurance, income protection, and life insurance if you need it. You will find that Japanese policies come with all kinds of add ons, fixed rate guarantees, and other bells and whistles. Start by looking for the simplest policies that cover your particular requirements, and beware of over-paying for things you don’t need.
  • Buying a home – owning versus renting becomes a bit of a no-brainer if you are going to be in Japan forever. You will likely find that you end up with more space for a lower monthly cost if you own your own home. Ultra low mortgage rates are, of course, an attractive factor. Whether you buy a house or an apartment is down to your own preference, but we will look at the pros and cons of each later.
  • Retirement planning – if you work in Japan you will already be paying into the Japan national pension. Once a year it is worth reviewing how this is going and what your pension is likely to be. If you are paying into the national pension scheme, you are also eligible to start a Japanese 401k, which is a self managed pension. This offers significant tax savings over time and is worth considering.
  • Savings – another tax efficient way to save is NISA, which is based on the UK ISA. NISA is relatively new and, although it does have its drawbacks, dividends and capital gains are tax free. Once you have exhausted ways to save that carry a tax benefit, you should look at opening a local brokerage account. This is a great way to invest in stocks and low cost ETFs.
  • Investment property – from one room apartments to whole buildings, there are excellent opportunities for property investment in Japan.
  • Lastly, consider if you have other base currencies? Keep in mind that if you are planning to send your kids to university overseas, for example, you should save for that need in the currency you will be spending in. Also, for general investment purposes, remember that Japan only accounts for around 8% of world stock market capitalisation. Investing too narrowly in Japan concentrates your risk in one area, and you also miss out on the opportunity to diversify into world markets.

The long-term expat

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Last time out we looked at the opportunity for short term expats. Today we move on to the long-termers. This is quite a loosely defined group, and will cover a broad section of the expat community. What we really mean by long term is:

  • You are not here on a short term expat posting – or you are but it is likely to renew many times before you move on.
  • You plan to leave the country you reside in at some point in the future, whether to go home, work somewhere else, or retire somewhere else.

This means you will spend a significant part of your life in your current country of residence. Let’s assume it’s Japan for clarity, but it could just as easily be Hong Kong, Singapore or elsewhere.

Once again, your number one financial planning issue is going to be base currency, and it’s quite possible you will have more than one. So you need to ask yourself what are the things you need to save for in the future, and what country are you planning on them taking place in? So if you are saving for retirement in Europe, you may have Euro as your base currency for that need. If you are planning on sending your child to college in the United States, you may have USD as your base currency for that. If you may actually end up staying in Japan forever you may need to keep some assets in JPY just in case.

My main point here is that currency risk can be a killer. I just found this interesting site that monitors national debt, and here is Japan’s debt clock. Now Japan may manage this well over the next 20 years, or it may not. What do you think will happen to the value of JPY if it doesn’t? If you are retiring in Europe, do you really want to be saving your money in JPY with a view to converting it later, when you move back?

Other than base currency, here are a few other things to consider:

  1. Protection – we have covered this in the protection review earlier. You should also have a plan for repatriation to your home country in case something goes wrong with your current employment and you have to leave in a hurry.
  2. Property – if you are going to be here for a long time then have you considered buying a property in Japan? Thanks to the developed world’s lowest interest rates, it can be very cost-effective when compared to renting. If you have the means, buying a property back home can also give you some extra income while you are away and a place to either go back to or sell to generate capital.
  3. Structuring – deciding where and how to hold particular investments is going to be important. You may have limited options for investing in Euros in Japan for example. It may be more tax effective to use an offshore structure or a structure back home. US citizens cannot escape worldwide taxation and need to think carefully about how to report assets. If you were to die, you probably want your assets be passed smoothly to your designated family members. Skilled advisers can add significant value here, just choose them carefully. (more on structuring in future posts)

The Expat Opportunity

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There are many different types of expats: some are posted overseas by their employer and do 2-3 year stints in a couple of countries and then return home. Some come as travelers, students or teachers and end up living and working overseas for a longer period. And some, like me, come for an adventure for a couple of years and never end up leaving! Whether you are a short term contractor, a long termer, or a lifer, the need to plan for your financial future is a constant. However, the method will vary depending on your circumstances. Over the next few posts we will consider each of these expat types and the opportunities available to them.

Today we will start with the shorter term expat contractors. If you belong to this group then I’m sure you are aware that you have an incredible opportunity to secure your financial future. You will probably never have as much disposable income as you have as an expat, and what you do with that income can really impact the rest of your life.

I recently spoke to someone who spent several years as an expat in Asia before returning to his home country and he told me: “I realise now that the investing I did in those years as an expat really set me up for a life of wealth.”

So what are some things you should be doing if you are here in Asia and enjoying the benefits of an “expat package”? Here are a few ideas:

  1. Make sure you understand what your base currency is. If you are unsure then this post will help you define it.
  2. Max out contributions to anything that gives you tax free growth first. This is most likely going to be pension type assets, such as a 401K or IRAs in the US, or ISAs in the UK.
  3. If you are paid in your base currency and receive a housing allowance in the country you are posted to, then you have a significant opportunity to invest back home or offshore. You may want to consider talking to an adviser both in your home country and a qualified expat adviser based in the country you are living in.
  4. Consider buying property in your home country, if you haven’t already. You have the option of renting it out while you are away, and you may achieve considerable capital growth over time too.
  5. Have a plan for how you are going to repatriate yourself and your family in case your employment comes to an unexpected end – you will need to plan for plane tickets, shipping belongings / furniture, and a place to live when you get home.

Most of all,  be sure to set aside some time for financial planning while you are away. The expat lifestyle can not only be fun and rewarding, but also incredibly busy. Make sure you don’t forget to make the most of the saving and investing opportunity of a lifetime.

 

 

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