This article was published on 16 June 2007. Some information may be out of date.

Q&As

  • A big fan of property investing scares me with his lack of knowledge.
  • I’m accused of hypocrisy and bias.
  • In praise of boring old index funds and learning about them.

Plus: KiwiSaver: Will the kick-start be around for a while? What happens when an employee gets a lump sum? A clarification about access to the money in bankruptcy.

QWould you borrow $300,000 to invest in shares? Would the banks lend it to you with shares as the equity?

All the time people are heavily geared into housing and can borrow for it, whereas they cannot in any other investment, unless you happen to be a private equity company of course.

So for people looking to invest, with only $10,000 for a deposit or none at all, the easy solution is to borrow someone else’s money, ie the bank’s, and let them take the risk of a big fall. A bonus is any capital gain is tax-free.

Ability to ratchet up your gearing with more properties and subsequent tax benefits magnifies the issue.

Note that for the one third of sales which are investment properties the effective mortgage interest rate is not 9 per cent, but 6 per cent because of the tax deduction. And only 1 per cent of the property price needs to be contributed to get 100 per cent of the tax-free gain. No wonder it makes sense.

If you are prepared to be aggressive and ‘start again’ after a bust, you should keep buying until you have a nest egg, then siphon money off to shares etc. But you will get there property-wise ten times faster because you will initially be heavily geared.

AYou scare me — especially if others think as you do.

Much of your letter is more or less correct. While people can borrow to invest in shares, it’s certainly harder than in property. And many people have, indeed, done really well because they have geared into property investments.

Ten times faster growth than in shares? Rarely, over periods long enough to count. But with heavily geared property and good luck, the growth can indeed be somewhat faster.

It’s really important to understand, though, that there’s no such thing as fast growth with low risk. And I’m afraid you’re wrong about who takes that risk. It’s not the bank; it’s you.

Let’s say, as you suggest, that you put $10,000 into a $310,000 rental property. In the current climate — with costs exceeding rental income — you will almost certainly put in quite a bit more during the investment. Still, if you sell for a big gain, it’s all dandy.

What happens, though, if the market falls? As I said last week, you’re fine if you can ride out the downturn.

But for all sorts of reasons people have to sell when prices are down. If the sale price is less than your mortgage — which is likely in a downturn if you have a small deposit — you not only lose your deposit. You are left owing the bank perhaps tens of thousands of dollars — sometimes even more — with nothing to show for it.

You blithely talk about starting again after a bust, but that’s not so easy financially or emotionally.

Just ask New Zealanders who, in spite of what you say, managed to borrow to buy shares in the mid 1980s. After the 1987 crash, many of them were in deep debt. And even though the share market now is much less risky than it was then, they never want to own shares again.

After a property dive, it would be similar.

A couple of other points:

  • Sure, the interest on rental property is cheaper after tax. But all the tax breaks on rental property — except depreciation, which can be clawed back — exist only because the landlord has to pay expenses. Even after the tax deductions, the landlord still pays more than half.

    With share investments, there are few tax breaks because there are few expenses.

  • On the capital gains issue, the same rules apply to shares as property. But gains on both are not tax-free if you bought with the purpose of selling at a profit.

And did you notice that the recent Budget gave Inland Revenue an extra $14.6 million to “expand its audit activity to ensure property speculators pay their fair share of tax,” according to Michael Cullen?

QYour column last Saturday left me breathless for its utter hypocrisy, even by your standards.

At the same time as you counsel a reader not to buy a rental property just now in our over-heated market, citing the negative experience of the Japanese property market (presumably over the past 17 years), you advocate the next reader should invest in index funds.

This at a time when most share markets, including ours, are similarly overheated. And you don’t mention the Japanese share market, which at 18,000 now is still significantly below the 38,900 peak the Nikkei Index reached in 1989, or indeed our own share market which is still below the peak set in 1987.

Amazing that you can talk about unbiased experts without recognising that you yourself are one of the most biased.

AFirst, inhale. We can’t have you turning blue. Then kindly explain to me how our share market can be overheated if it’s still below where it was in 1987?

In fact, neither is true, especially the historical bit. New Zealand share indexes, including dividends, are more than twice the level they reached in 1987.

Perhaps you’re one of those who thinks dividends shouldn’t be included. But that makes no more sense than excluding rental income from property investment.

Overheated? Some have said so, but if you look at the long-term trend, current levels don’t look as seriously out of line as they do in property.

I’m not saying the New Zealand share market won’t fall soon. I don’t do forecasts. But I am saying that if you have a ten-year-plus horizon — which is what you should have for property or shares — I think shares look okay. That’s where my long-term savings are, along with my house.

As for bias, I’m sorry if I come across that way. At least it’s not because I’m trying to sell you something.

I don’t feel anti-property and pro-shares — which is what I assume you are suggesting. I’ve done well with property over the years.

But, as I’ve said so often it’s like a broken record, I worry that New Zealanders like our previous correspondent don’t appreciate the risks they sometimes take with property.

QMost people have not studied finance and hence have a limited understanding of the well-proven theory of efficient markets.

Academics are generally not as eloquent as financial journalists and therefore not as able as you in presenting ideas in a simple manner.

You play an important role in educating ordinary Kiwis on the virtues of the tried and tested but unfortunately boring strategy of investing in index funds.

We all like the idea of ourselves being smarter than the average guy, which is why it’s a real blow to the ego to admit to the wisdom of crowds.

AThanks for an encouraging letter, which I wouldn’t normally publish. But I just wanted to show the previous correspondent that I’m not alone in recommending index funds.

And, by the way, you’re quite right that they are rather boring investments. But that’s fine with me. It leaves plenty of time for beaches and novels.

QAbout the $1000 kick-start for KiwiSaver. If you want to wait to join for say three years, till your employer is contributing enough, do you still get the $1000?

Also, if you opt out after six weeks and then want to join later, do you get the $1000?

AYes and yes, as long as the government — or a new government after next election — doesn’t change the rules.

That’s the risk you run by waiting, although I haven’t heard National suggest it would get rid of the kick-start.

Under the current rules, everyone gets one go at the kick-start, regardless of when they join. The money goes into your account after you’ve been in the scheme for three months.

People with new jobs who are automatically signed up, but want to opt out, must do so before the end of eight weeks. So they won’t get the kick-start unless they rejoin later.

QI am due a lump sum payment from my employer at around July 1 when I plan to join KiwiSaver, paying 4 per cent with my employer putting in 4 per cent by way of salary sacrifice.

If I receive the lump sum after July 1, am I obligated to contribute 4 per cent of it to KiwiSaver?

AYes. The 4 per cent applies to your total remuneration, including bonuses, overtime, holiday pay and redundancy pay. You might want to wait until you have received the lump sum before you sign up.

For future reference, once you’ve been in KiwiSaver for a year, you can take a contributions holiday of three months to five years, or shorter if your employer agrees to it.

So, if you have a further lump sum coming and you don’t want 4 per cent of that money to be tied up, you might take a well timed contributions holiday.

CLARIFICATION

While we’re on KiwiSaver, in the special section on KiwiSaver in the Herald on Wednesday, June 6, I wrote:

“It might be worth noting that, if you are made bankrupt, generally creditors won’t have access to the money in your KiwiSaver account — unless you have deliberately placed money there to keep it away from creditors.

“It follows, then, that it might be better not to apply for a financial hardship withdrawal if that is unlikely to stop you going bankrupt. It will probably be better to leave your KiwiSaver savings untouched.”

I got the information from a government official. Since then, another official has said that the question of access to KiwiSaver money in a bankruptcy hasn’t yet been decided.

At my suggestion, the two spoke together, but both are sticking to their stories. They did say, though, that the government will come out with a statement on the subject some time in the next few months. I’ll let you know as soon as I hear more.

Don’t blame the officials. Confusion is what happens when a government changes a major policy just six weeks before it is to be implemented.

Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to [email protected] or click here. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.