NZ Herald 3 October 2015

AProbably more than half of all New Zealanders invest in bonds — often through their KiwiSaver funds. But many don’t really know what they are.

Bonds are basically loans. You or your KiwiSaver fund manager lends a sum of money for a period. In return — if all goes well — you get regular interest payments and your money back at the end.

In many ways bonds are like bank term deposits. But with deposits you’re on a straightforward journey and highly likely to get to your destination. With bonds there are good stretches with great weather and a clear road, but also difficult stretches. Occasionally you won’t make it to the end. Usually, though, it’s a more rewarding journey than a boring term deposit trip.

Bonds are issued by everyone from the government — whose bonds are the safest in terms of interest payments and getting your money back — to companies of all sorts. If a company gets into financial trouble, it might stop paying interest and may default at the end. Remember the failed finance companies a few years back?

The varying levels of risk are matched by varying interest rates. Generally, corporate bonds pay more than the government because they’re at least a bit riskier. High-risk companies have to pay considerably more, or nobody would invest in them. Bonds also tend to pay more than bank term deposits, but not always.

You can get a good idea of a company’s risk from its credit rating. The ratings range from AAA down to D if the company is in default. Experts say its best to stick with “investment grade bonds”, which are rated AAA, AA, A or BBB. But you might be willing to take on more risk in exchange for higher interest.

For more on credit ratings see the Reserve Bank’s easy-to-read info at tinyurl.com/cratings.

The big difference between term deposits and bonds — the reason the bond journey has its ups and downs — is that you can buy or sell most bonds before maturity. It’s good to be able to access your money. But if you sell before maturity you will probably get more or less than you paid for the bond.

Why? Let’s say that three years ago you bought a $10,000 five-year bond that pays 6 per cent. Now you want to sell it.

Since then, interest rates on bonds with similar risk have fallen. So buyers, keen to get your bond, may pay you $11,000 for it. They will still get only $10,000 at maturity, but they like the higher interest in the meantime.

If, instead, interest rates had risen, nobody would want your bond unless they could buy it cheaply — for, says, $9,000.

The rule: if interest rates fall, previously issued bonds rise, and the reverse.

None of this will affect you if you hold your bond to maturity — which is what most direct bondholders do.

But the managers of KiwiSaver or other funds that hold bonds have to regularly “mark to market”, which means value their bonds and allocate returns at the prices they would get if they sold that day.

That’s fair, because some investors will withdraw money that day. But it does mean the value of funds that hold bonds wobbles around. Generally the wobbles won’t be as big as in a share fund, but they can still be considerable.

If you don’t want that volatility — or you plan to spend your money in the next two or three years — you can move to a cash fund, which holds bank term deposits and short-term investments whose value doesn’t fluctuate.

AIf you’re over 65 and have been in KiwiSaver for more than five years, you can withdraw any or all of the money at any time. So it’s more accessible than a term deposit.

But there are two “howevers”. Firstly, the fact that your returns are much higher than on bank deposits suggests you’re in a higher-risk KiwiSaver fund. While your account is likely to grow faster over the long term, its value will fall, sometimes a lot. It’s suitable only if:

• You don’t plan to spend the money for ten years or more.
• You won’t bail out when the markets fall.

If you can’t say “yes” to both, it would be wise to move to a lower risk KiwiSaver fund — although even then the ride may not be entirely smooth. See the next Q&A.

The second “however” is about possible changes to KiwiSaver. A government might decide to limit how much you can withdraw each year. And they would probably do that without warning, to prevent retired people from emptying their accounts before the change took effect.

One way around this would be to see if your provider has a similar non-KiwiSaver fund — preferably with similar or lower fees — and switching to that.

AAs you probably realise, the NZ Super Fund — or Cullen Fund — is for government money only. And while it’s performed really well recently, just six years ago, in the global financial crisis, its annual return was minus 12.9 per cent.

The Cullen Fund invests for the really long term. The plan is for the money to help fund NZ Super several decades from now. Because of that, its investments have good long-term growth prospects but shorter-term volatility.

Meanwhile, back at your place, you’re looking at a very short-term loss.

Default KiwiSaver funds hold just 15 to 25 per cent growth assets — shares and to a lesser extent property. The rest is lower-risk bonds and cash — usually mainly bonds because their long-term returns tend to be higher than cash.

In the last couple of months, long-term interest rates have risen a little. And, as explained in today’s first Q&A, that reduces the value of bonds. Sure, interest income still comes in, but in the current low-interest environment that may not offset declines in bond value.

At the same time, share markets haven’t fared well in recent months, so that portion of your fund’s portfolio won’t have helped. Recent drops in the value of many KiwiSaver funds are to be expected.

Turning to your questions, growth funds have probably fallen more in this period. But certainly not always. The bond and share markets can move very differently.

Was your decision good? Probably, if you’re not planning to spend the money in the next couple of years — but see the previous Q&A.

It’s certainly unwise to judge an investment over such a short period. Over the past five years, the average return on conservative KiwiSaver funds has been 5.1 per cent, according to Sorted’s KiwiSaver Fund Finder. There are no guarantees for the future, but we expect long-term returns to be somewhat higher than on bank term deposits.

Next week: More on KiwiSaver versus term deposits, but for those not yet retired.

AFirstly, sorry for your loss. And what a great idea to enable donations to a cause your daughter loved.

For the benefit of others, givealittle.co.nz is a crowdfunding website, where people can contribute as little as $1 to a cause.

Givealittle confirms that it will direct funds only into a New Zealand-based bank account. Adds a spokesperson, “We would advise this person to create a Givealittle page using the bank account that they’ve opened, but to set it up as a page owned by themselves as an individual.

This is so that it doesn’t appear to any donors that they are donating directly to the organisation. However, the fundraiser would outline in their page description what the intended purpose of the funds is.

“We would then request a letter from the organisation to confirm that they are happy for the funds raised to go to this individual before being transferred to their account. This is standard practice, and would also be done if an individual was fundraising on behalf of another.”

I hope that all sounds workable. What about tax? The news is good on income tax.

Says an Inland Revenue spokesperson, “On the basis that the writer will be setting up a bank account to directly receive people’s donations, if the money paid into that account is subsequently paid in full to the conservation centre, then they would not need to declare that money, as it will not be income to them.”

However, it’s not so good on a tax credit for donors.

“It would seem that the writer has not registered with the Charities Services Division of the Department of Internal Affairs, and as it is apparent that this money will ultimately be sent overseas, it is unlikely that they would be granted charitable status anyhow. Consequently, donors will not be eligible for a donations tax credit,” says the spokesperson.

Still, hopefully friends and family will donate anyway.

Note to other readers: I sent this Q&A early to this correspondent so he could go ahead with his plans. The Givealittle page has now been created.