NZ Herald 20 August 2011

AIt’s never ignorant to allow for tax and inflation. Note, though, that inflation affects every investment, and tax affects most.

For those who missed last week’s column, I said conservative investing was like taking a long trip in a reliable little fishing boat that brings in a small but steady catch.

On the other hand, more aggressive investing — usually mainly in shares but it could be in property — is like being on a bigger boat on the open sea. Sometimes you get nothing but seasickness but sometimes you catch plenty. Over the long term, the bigger boat’s haul will probably be larger.

Your reluctance to board either boat is a worry. Unless you are really wealthy, it seems foolhardy not to save at all. I suggest you at least embark on the slow and steady vessel.

However, the bigger boat does offer a rougher ride. And perhaps I made things look too cruisy last week. It’s just that allowing for returns with and without dividends, with and without tax and with and without inflation all at once can get confusing.

This week, then, let’s concentrate on tax and inflation — followed by your point about the NZX 40 changing.

Our graph shows, firstly, how $1000 in an NZX 40 index fund grew in the ten years starting June 30 2001, before tax. The investment came just shy of doubling, with an annual average return of 6.99 per cent.

Next we see how tax affects returns, as calculated by Michael Chamberlain of MCA NZ Ltd. In a KiwiSaver, superannuation or other fund investment — which would almost certainly be a PIE — the top tax rate is 28 per cent, so that’s what he used.

Capital gains in index funds are usually not taxed, and dividends are only partly taxed, because imputation takes into account tax already paid by a company before it hands out dividends. So the total tax impact is not huge — and would be even less in a period of high capital gains. Tax reduces the average return to 5.02 per cent.

Finally, we take out inflation, reducing the real return to just 2.13 per cent a year. After tax and inflation, the buying power of $1000 has grown to $1235.

What about the changing composition of the NZX 40 index of the country’s 40 biggest shares? That shouldn’t affect anything.

Some shares leave an index because the company is taken over by another company. That’s usually fine for shareholders, who are often paid well for their shares.

Other shares leave because they lose value and drop off the top 40 list. But if Loser Co falls to 41st place, Gainer Co rises to 40th. The index fund sells Loser and buys Gainer and life goes on. Quite often, Gainer is an up and coming company that proceeds to make a great contribution to the fund’s performance. It’s good old swings and roundabouts.

Let’s get back, then, to our $1235 after tax and inflation. That doesn’t sound much better than you might do in term deposits or bonds. The global financial crisis has made it a rough decade for shares.

Over longer periods, however, shares have performed better than the alternatives. Nobody knows what the future holds, but logic says that will probably continue, because returns tend to reflect risk over the long term.

And remember that even small differences in average returns compound to a large difference over several decades. In the ten years to June 2011, the real after tax return on cash was 1.44 per cent a year. If we compare the 2.13 per cent on shares with the 1.44 on cash, over 40 years you would have 31 per cent more in shares.

Adds Chamberlain, “If they invested regularly in shares they would have been better off again, because of the mathematics of dollar cost averaging.” This is a result of fluctuating share prices. If you invest the same amount regularly, you buy more shares when prices are low. That reduces your average share price.

Still not convinced? If you prefer to stick with the slow and steady boat, I won’t try to talk you out of it.

AYours is one of the gentler letters I received about gold after I said, last week, that “gold is looking horribly bubbly. I do not recommend investing in it.”

The fact that the subeditor used that quote in big letters may have led some readers to think I was yelling it from the rooftops. I was really just trying to say, “Hey, despite gold’s soaring price, I don’t think it’s wise to rush out and move your money into bullion. Some experts I respect say it’s overpriced.”

Sorry if I overstated the case. I didn’t mean to imply that if someone has a small portion of their savings in gold, they should get rid of that. But I don’t think gold is the place for the bulk of ordinary New Zealanders’ savings.

Beyond that, I don’t want an argument either. We’ve done that already a while back. Go for it, gold bugs!

AI can understand your confusion. The labels on the tables are not as clear as they could be, and they are slightly different on the Sorted and Work and Income websites, which doesn’t help. Nevertheless, there are tables on both sites and the numbers are consistent.

Let’s look at the Work and Income (formerly WINZ) website. For a list of NZ Super payments at different tax rates, go to tinyurl.com/NZSuper1.

If you want the payments the 65-year-old will receive, without taking the 64-year-old into account, look at “Married person or partner in a civil union or de facto relationship”.

If you include a “non-qualified” partner who is under 65, look at the payments for “Married or in a civil union or de facto relationship, non-qualified partner included on or after 1 October 1991”.

The payments in the latter case will be reduced if a couple’s before-tax income — other than from NZ Super — is more than $100 a week. But as long as it is less than $24,703 a year, the couple will be better off including the non-qualified partner. It sounds as if that would apply to you.

For more info, see tinyurl.com/NZSuper2. Under the heading, “Including your partner in your payments”, we’re told, “If you earn more than $100 (before tax) a week your payments are reduced by 70 cents for every dollar of income over $100 (before tax).”

“As an example,” says a Ministry of Social Development spokesperson, “if the couple’s total income before tax is $350, the assessment would ignore the first $100, leaving an excess of $250 per week.

“Applying the 70 cents reduction for every dollar of income over $100, this would result in a reduction of $175 per week from the combined maximum gross rate of NZ Super of $556.62 per week, leaving $381.62 gross per week total (or $763.24 gross per fortnight total).

“That compares favourably with the amount of $588.16 gross per fortnight that the 65-year-old would receive if they chose not to include the 64-year-old.”

He adds, “As everyone’s situation varies, we encourage people to contact us so that we can take into account their individual situation and give them advice on which option would work best for them.”

How to contact Work and Income? Well maybe the phone isn’t quite as bad as you think.

“Our dedicated NZ Super line (0800 552 002) is open from 8am to 5pm Monday to Friday,” says the spokesperson. “The majority of our callers tend to ring us on Mondays or Fridays and mornings are always busier than afternoons. So if a reader wants to talk to us, their best bet is to call us mid-week after lunch.”

There is also a brochure called New Zealand Superannuation available on the website or from Work and Income service centres. You could pop in and pick one up.