NZ Herald 28 October 2006

AYou’re quite right. Over that particular period, rear view investing would have been best.

That’s not surprising, though. As my column said, “You might do well if you put money into last year’s best performer. But quite often you won’t.”

Looking at just one period in one country can be really misleading.

To quote from the column again, Australian researchers “assessed about 100 studies done in various countries over 20 years. About half the studies found no relationship between good past and future performance.

“In some other studies, there was some relationship, but usually only in the short term. If you invested on the strength of that knowledge, you would be moving your money around frequently.

“That would be not only time-consuming, but any gains you made from the strategy would probably be eaten up in brokerage, fees and possibly tax on capital gains.”

That’s something you didn’t allow for in your number crunching. And it makes a big difference to returns.

Over all, the Australians — and British researchers who did a similar study — concluded that past performance is not a useful guide for the future.

It’s cheaper, easier, and often more profitable to work out what is your best choice of assets for the long term and stick with it.

A couple of other points:

• The period in question was an unusually volatile one for overseas shares. In many other periods they have outperformed property and NZ shares.
• A balanced portfolio will always give only an average performance. Mathematically, it must.

  Many people prefer balance because the performance is much less volatile than if you concentrate on one or two types of assets, especially if they are shares and/or property.

  But those who can cope with some big negative returns will usually do better over the long term with just shares and/or property. And your “rear view” strategy almost always meant investing in shares or property.

• The main point of including the table was to show that on four occasions in the last ten years the worst performing asset one year was best the next year, or the reverse.

  It was merely an example of what can happen, and not nearly enough data from which to draw conclusions.

Still, good on you for your challenge. There’s no predicting what readers will get up to!

AStop! Let’s not get into election spending in this column. But I agree with you about the limited submissions.

And I like your argument that encouraging offshore investment would boost tax revenue.

David Carrigan of Inland Revenue doesn’t argue vehemently against it either. “He has a good point,” he says, but adds “in a make-believe world he’s right. But it only holds if we make unrealistic assumptions.”

Those assumptions are:

• That foreigners invest in New Zealand companies via owning shares (called equity investing) rather than via lending the company money (debt investing).
• That New Zealand companies earn all their income in New Zealand.

On the first assumption, the fact is that “around 70 per cent of the capital from offshore to fund our companies is debt rather than equity,” says Carrigan. Foreign investors receive tax advantages from doing it that way.

And when a New Zealand company pays interest on that debt, it can deduct the interest for tax purposes. In many cases, then, foreign investment in a New Zealand company reduces the company’s tax. So the government has less for hospitals and schools.

On the second assumption, some New Zealand companies, of course, earn money offshore. In that case, tax on the company’s foreign income is reduced to the extent the company is owned by foreigners.

Again, the more foreign investors there are, the less money there is for schools and hospitals.

This is a simplification of a complex argument, which economists frequently debate, says Carrigan. I should probably scatter the word “generally” throughout, to keep at bay those who will write to say, “Paragraph x is not always correct.”

Suffice to say that these things are often not as simple as they seem.

Speaking of which, another reader wrote about my statement, last week, that the UK doesn’t have dividend imputation.

“Most UK dividends do carry a tax credit of 10 per cent,” he said, adding that this credit used to be accepted in the same way as a New Zealand imputation credit, but no longer.

He added some fighting words: “This is further evidence that this Government’s tax policy I believe is driven more by spite and outdated socialist ideology than common sense. Witness for example the immediate introduction of a 39 per cent rate on principle rather than need.”

A“It’s true that we don’t tax all income comprehensively,” says Carrigan. “I don’t know of anywhere in the world that does.

“But if we’re looking at investments that are broadly substitutable, New Zealanders could lend money to an offshore company, and they would then be taxed very comprehensively. If instead they buy shares in it, it seems reasonable to levy a reasonable level of tax on that.”

On Gold Coast property, he notes, rental income is taxable. “People may argue that the depreciation rate is still too high — although the rate has recently been reduced — but the income is still taxed.”

More generally, he says, “We can’t fix everything at the same time.”

Fair enough. But — in the interests of encouraging New Zealanders to diversify their investments — I do hope the government moves on quickly to look at such issues as the application of capital gains rules to rental properties.

On the 10 per cent issue, Carrigan says Inland Revenue is at the moment reviewing the taxation of controlled foreign companies, “which may have flow-on implications for those with corporate holdings bigger than 10 per cent. A discussion document is expected to come out later in the year.”

Who knows? The very wealthy might end up worse off than the rest of us.