NZ Herald 16 May 2020

AGosh! Am I part of a conspiracy to help out professional investors at the expense of readers?

Well no.

Let’s start by assuming — falsely — that it’s possible to pick a good time to sell shares, and a good time to buy back in again.

Some fund managers and other professionals say they can do it. Perhaps they called it right and sold shares before the recent market plunge. And they plan to get back into shares just before they rise again.

The markets have, of course, already regained more than half their Covid-19 losses. I wonder if these people got back in before that happened, or whether they’re waiting to see if we have another plunge — and have meanwhile missed some healthy gains.

It’s tricky stuff, this market timing. As I said last week — which I should note was after you wrote to me — world champion share investor Warren Buffett doesn’t try. Do you really think small investors have much chance of getting it right?

Think about what would happen if I were to say to readers, “The market’s gone wobbly. Get out as soon as you can and come back in when it settles.”

By the time I said that, of course, share prices would already have dropped. And readers are highly likely not to get back into shares until too late. It’s not that they will forget, but they’ll wait until they’ve seen at least several days, if not weeks, of steady price rises — and therefore miss those gains.

Here’s a key point: For everyone who sells shares at just the right time, there has to be someone who buys those shares at just the wrong time. Ditto for everyone who buys back into the market at just the right time. Someone sold to them, and lived to regret it.

And who is more likely to be on the wrong side of those trades — the professional who spends all day watching market developments or the small investor?

History has shown us over and over that ordinary investors are better off sitting on the sidelines. And, by the way, many top professionals do just that too.

ATo my knowledge, Simplicity is the only KiwiSaver provider that doesn’t let members be in more than one of its funds.

Most providers will also let you contribute to more than one fund, or contribute to one fund while leaving your earlier savings in another one. If you want to do something like that and your provider won’t let you, switch to one that will. To switch, just ask the new provider to arrange it.

I don’t know of any provider that allows you to set up an automatic gradual transfer of, say, 20 per cent of your money from one fund to another every month. But you can always just contact them monthly.

Apart from gradually changing your risk level, other reasons for being in more than one fund are:

• You want to try a higher-risk fund with a portion of your savings, to see how you cope with the greater volatility, before perhaps moving the whole lot to higher risk.
• In retirement, it’s good to have the money you plan to spend in the next few years in lower risk, but the longer-term money in higher risk.

Simplicity explains its policy this way: “True to our brand, and our philosophy, we choose to offer only three core funds in KiwiSaver as we didn’t want to overcomplicate things for ourselves and our clients. Limiting our investors to one fund type simplifies reporting and registry requirements and keeps costs down for members.”

Fair enough. You pay less and get less — which is fine for those who don’t need to be in more than one fund.

AYou’ve missed quite a lot actually. The situation is much better than you think.

I suspect many investors in KiwiSaver and other managed funds don’t realise how they’re taxed, because it’s all taken care of by the provider.

All KiwiSaver funds and probably all other managed funds are portfolio investment entities, or PIEs. And the good news is that investments in PIEs are taxed pretty gently.

For a start, PIE tax rates are a bit lower. For example, the top tax rate is 28 per cent, compared with 33 per cent on other income.

Also, basically you pay tax on income earned in the fund — such as interest and dividends — but not on gains in the value of the investments.

However, the dividend situation is a little bit complicated:

• On New Zealand shares you end up paying little tax on dividends. Under our dividend imputation system, shareholders get credit for the tax the company has already paid on its profits, so there’s no further tax on many shares. What’s more, investors in lower tax brackets sometimes end up with excess imputation credits, which can then reduce their tax on interest.
• In Australia there’s a similar system, called franking, but New Zealanders don’t benefit from it. So KiwiSaver members and others pay tax on the full Aussie dividends received.
• On shares from other countries, instead of paying tax on the dividends there’s a special tax of 5 per cent of the value of the shares — regardless of whether the shares have paid dividends or gained or lost value.

Turning to your example, on both occasions when the fund value rises, much of that is probably because of changes in the values of investments, and you’re not taxed on that.

However, there will be some interest and dividends as well, and you will be taxed on those as just outlined.

It might be helpful to think of your KiwiSaver account as being like a rental property that you have no plans to sell. Each year you pay tax on the rent minus expenses. Meanwhile, the value of the property goes up, and sometimes down, but that is not taxed.

AFor the benefit of other readers, if you use a limit buy — or buy limit — you put in an order to buy a share, but only if you can get it for $x or less. You can also use a limit sell, specifying a price that you won’t go below.

If, instead, you were to use an ordinary market order to buy a share, you might pay a bit more — or potentially a lot more if the share price zoomed up before the transaction took place.

A limit buy would work particularly well if you wanted to buy an infrequently traded share, where it’s hard to predict what price you might otherwise pay.

However, you’d be wise to keep an eye on your limit buys, which last for 30 days unless you cancel them. During that time, a company might announce some bad news, and the share price falls. You would end up paying your price on the way down, where otherwise you would probably have waited until the price settled.

Also, as you realise, if you set too low a price you won’t get the shares. If you really want a certain share, you have to set the limit close to the current price or the purchase might not happen. That means that while you get a bargain, it’s not a big bargain.

But if you’re less fussed about what you buy, you could put in low limit buy orders for lots of shares, and end up with the ones that got cheap enough.

Would that randomness matter? Perhaps not. I’ve written before about how monkeys have picked shares — or people have thrown darts at a newspaper share table and bought whatever they hit — and done better than people who spend hours agonizing over what to buy.

So what’s my opinion? By all means use limit buys, as long as you’re watchful. Buying bargains is good — although I doubt if it will make all that much difference over the long haul.

By the way, ASB, Hatch and perhaps other sharebrokers also offer limit buys and sells.

Footnote: Suddenly I’m getting questions about share trading. That hasn’t happened for a while. It’s good to see, as long as people are buying for the long term, as you are. Short-term trading doesn’t work out well for most people.

AI, for one, have always said paying extra off a mortgage tends to work better for most people than investing in, say, a share fund.

The argument went like this: “If you pay down a 5 per cent mortgage, that improves your wealth as much as earning 5 per cent on an investment. Sure, a share fund investment might average more than 5 per cent, after fees and tax, over the years. But the return is volatile, and the investment has some risk, whereas mortgage payments are risk-free.”

Other advantages of paying down a mortgage include:

• Being mortgage-free sooner puts you in a strong financial position. Your accommodation is taken care of. And if you need to borrow for something, you can usually raise another mortgage.
• You don’t have to think about how to invest. Paying down a mortgage is simple.

However, a 3 per cent mortgage interest rate does change the balance somewhat.

While share markets have been really volatile lately, long-term returns should still be well above 3 per cent. So you’re probably doing the right thing, as long as:

• Your investment is fairly high risk — because otherwise you’re less likely to get a higher return than the mortgage interest rate.
• You can cope with volatility, and won’t lower your risk during downturns.
• You’re investing for ten years or more — to reduce the chance you’ll be hit by a downturn close to when you want to spend the money.
• You’re in a strong position financially, with secure income.

For another argument in favour of your plan, read on.

AYou’re right that putting all your money into buying a house, or paying down a mortgage, means you miss out on diversification from investing in, say, an international share fund.

You also miss out on learning about how the markets rise and fall — useful knowledge, as recent events illustrate!

Because of that, back before KiwiSaver started in 2007, I used to suggest people do a little share fund investing alongside paying off their mortgage.

These days almost everyone is in KiwiSaver. And if they’re in a medium or higher-risk fund, they often have a fair bit in shares.

But if you want to have more, I won’t argue — especially in these low-interest times — as long as you can tick everything on the checklist above.

AI wonder if your son-in-law-to-be (SILTB) is keen to get rid of the mortgage to even things up with your daughter — so that each has paid for, say, half the house. He might find the current situation a bit uncomfortable, and that’s understandable.

However, I do agree with your daughter and you. It sounds as if SILTB is an employee, in which case every dollar he puts into KiwiSaver would be roughly doubled by the government and his employer.

Even if he’s self-employed, he can contribute $1,043 a year, and the government contribution will boost that by 50 per cent.

Add the current low mortgage rates to the picture and being in KiwiSaver is a pretty clear winner over making extra mortgage payments.

Still, I suggest he puts only enough into KiwiSaver to get the incentives — 3 per cent if employed and $1,043 a year otherwise.

Beyond that? While the correspondents above prefer investing, there’s still nothing wrong with killing off a mortgage quickly, especially when approaching retirement.

Note for SILTB: If I were you, I might resent my partner and their parent telling me what to do with my finances! But perhaps let them win this one. It’s a pity to miss out on free money.

AThis is a new twist on the mortgage versus investing theme. You’ve obviously got a mortgage and chosen not to use your KiwiSaver money — now that you can access it — to reduce the loan. Now you’re considering taking that one big step further, by adding to the mortgage.

Make no mistake about it, a so-called mortgage holiday is actually a mortgage addition. You’ll have to make bigger payments in future or extend the term of the loan or both.

But that’s not necessarily bad. It boils down to whether you can make a higher return on your KiwiSaver money over the next six months than the rate you’re paying on your mortgage.

It’s a gamble. You might do brilliantly. But as the last couple of months have shown, bad stuff can happen to growth funds over short periods. And we could be in for further falls.

Work through a worst case scenario. How would you feel if your KiwiSaver account halves or worse while your mortgage balance is growing?

Maybe that would be tolerable. Perhaps you won’t need to spend the KiwiSaver money for years, so there’s time for it to recover. Or perhaps you’re planning to trade down to a cheaper house, thereby freeing up more retirement savings.

If you could cope, go for it. And good luck!

P.S. You might want to do some reading on what’s worth upgrading in your house, or perhaps ask a real estate agent. Some spending is often not recovered in a higher sale price.