NZ Herald 13 April 2024

AI can’t take credit for the idea. A friend did it first. But it does tend to work well. It can teach the young person valuable financial lessons — as well as giving their parents a break from requests for expensive branded clothes or other “unnecessary stuff”.

Before you start, I think it’s best to talk with the teen about what’s a reasonable annual amount. They will probably welcome the chance to buy items without having to convince you. But parents should continue to provide clothing like socks, undies and pyjamas, or your child may end up short of them. And of course you need to keep paying for school uniforms.

The key to success is that you must be willing to step aside and watch the teen making purchases you know they’ll regret.

My son, like yours, blew the lot early in the first year on some brand clothes. It was quite hard to ignore his pleas for more money later in the year. But he didn’t do that again.

AThe experts disagree on this. But first, let’s explain the situation to other readers.

Index funds — sometimes called passive funds — invest in all the shares in a sharemarket index. Unlike active funds, they don’t trade shares except when the index changes. The funds are cheap to run — as they do no research on what to buy and sell — so their fees are usually low.

Because they trade rarely, index funds don’t contribute much to the process by which share prices are set, sometimes called price discovery.

This involves the decisions of active fund managers and other investors. They analyse a company’s data and the price of its shares, and if they think they’re undervalued — that the company will do better in future than most people realise — they buy. As more and more people come to this conclusion, the buying pressure pushes up the share price, until the shares become accurately valued.

Similarly, as fund managers and other investors realise a share is overvalued, they will sell, pushing the share price down.

Over time, as a company’s situation changes, its price changes, through price discovery.

The trick for investors is to realise a share is undervalued before others do, and rush to buy before the price rises. Or to realise first that a share is overvalued, and sell before the price falls.

Our correspondent’s concern, and that of many others, is that if most people invest in index funds, there will be too few people analysing companies and share prices won’t be set efficiently.

This doesn’t worry Dean Anderson, CEO of KiwiSaver and investment provider Kernel, which runs lots of passive funds. What matters is not how many shares are owned actively versus passively, but the share of trading volumes, he says.

“Passive funds’ turnover is very low, so most of the data at the moment shows that while passive owns about 35 per cent of the US market, it actually is only responsible for about 10 per cent of trading i.e. the impact on market efficiency and price discovery is negligible.

“If you model this out, you have to get to circa 80 per cent of the market held via index funds before half of the trading value is from index funds.”

A further point I often make: If we got to that stage, there wouldn’t be many active fund managers left who were seeking undervalued shares. So it would be easier to be amongst the first to find and buy those shares before their price rises.

Active managers would then outperform index funds often. Many index fund investors would move to those active funds, until we got back to the current situation, in which analysts don’t often beat the indexes.

Financial adviser Brent Sheather has been buying passive funds personally and for clients since 1989, but he doesn’t buy this argument.

“It ignores the momentum effect and the fact that ‘markets can remain illogical for longer than you can stay solvent’,” he says, quoting economist John Maynard Keyes.

“I worry that sooner or later we are going to have a big blow-up, and passive investment will get the blame. That is the last thing we want.

“Price signals from the stock market are used by capitalist economies to allocate capital and labour. So they are far more important than just determining the fair market price of individual stocks.

“Everybody has a responsibility to pay for the cost of price discovery. How would you feel if every morning your neighbours rang you up and said. ‘Can you give us a lift in your car, and by the way also let us know where we are supposed to be going?’.

“It is about time passive investors and their cheerleaders realize what’s at stake and that everyone has an obligation to pay for price discovery. Furthermore low cost active funds exist, so doing the right thing does not need to be painful.

“Bottom line is that best practice is a mix of passive and active funds, and remember low-cost active exists. One just has to do the mahi.”

Sheather doesn’t see imminent disaster, though. “I’ve just been talking to a journalist from the Financial Times on this topic, and he made the point that there are a huge number of hedge funds actively stock picking, so he is reasonably relaxed that price discovery is alive and well.”

AI’m pretty sure all KiwiSaver funds are PIE funds, which are taxed at a somewhat lower rate than other income for most people. But probably all other investment funds are also PIEs. So as long as you move to another PIE fund, there will be no difference taxwise.

As you say, you can withdraw money from a non-KiwiSaver fund whenever you need it, which can be a big advantage at curveball times, not just for you but perhaps a family member. The only people who wouldn’t benefit from such a move are those who might be tempted to spend the money on silly stuff.

AI’m afraid you’ve got my message a bit wrong on several counts:

• As I explained last week, I recommend moving your money from an aggressive or growth fund to medium — not low — risk when you are about ten — not five — years from spending it. And then move to a lowest-risk defensive or cash fund when you are about three years from spending it.
• We need to differentiate between the money you expect to spend early in retirement and your longer-term savings. Many people live into their nineties or older these days. So, while it’s best to reduce risk for the savings you plan to spend soon, it’s good to keep your longer-term money in a higher-risk fund until you’re within about ten years of spending it, as long as you stick with the plan and don’t panic through market downturns.

Now to your question. If you’re happy to keep working for longer if the markets plunge within the next five years, why not stay put?

Be aware, though, that every now and then share markets don’t fully recover from a plunge for ten years or so. Would you be content to retire with considerably less than you have now? Or to stay in the work force for another decade or so?

If not, you might want to reduce risk on just your early retirement money. By all means leave the cash for your riotous 90^th birthday world trip where it is for a while yet.

AI take your point. While few countries that tax capital gains make adjustments for inflation — probably because it could get horrendously complicated — it’s quite common to tax gains at a lower rate than income tax. And the rationale for this is often the inflation issue.

As I’ve said before, I would love to see our Government look at the best features of capital gains taxes around the world and incorporate them into a good tax for us.

By the way, tax rates on wages and salaries are not adjusted for inflation either. The cutoff points between the rates — for example the $48,000 of annual taxable income, above which the tax rate changes from 17.5 per cent to 30 per cent — should be regularly inflation-adjusted. But not to some amount like $51,342.78! The nearest $1,000 would be good.