NZ Herald 30 August 2014

AFor the benefit of others, SmartMozy invests in the shares in the Australian MidCap 50 index — shares ranked 51st to 100th on the Australian stock exchange.

As an index fund, SmartMozy trades only when the index changes. It’s therefore much cheaper to run than funds in which the managers actively trade shares, so the fees are usually considerably lower. This is a major reason why I recommend index funds — sometimes called passive or tracker funds.

SmartMozy is also an exchange traded fund, meaning you can buy and sell shares in the fund on the share market.

Okay, on to your situation. You’re right that the investment is probably safe in the sense that your money almost certainly won’t disappear. And yes, we expect higher average returns than in, say, bank term deposits, because you’re investing in shares.

But — contrary to your first sentence — I wouldn’t call share index funds “low risk”. They are not a good place for investments of less than ten years. Over shorter periods, share markets sometimes fall a lot, and that’s exactly what’s happened to you.

Furthermore, SmartMozy is unhedged against the Australian dollar, so your investment will fluctuate with changes in the Kiwi-Aussie dollar exchange rate. And in the last three years or so, the exchange rate has also moved against you. You’ve been hit by a double whammy.

Smartshares, the NZX subsidiary that runs SmartMozy, says the currency risk is pointed out in their investment statement — although it’s not mentioned in their one-page online fact sheet, and I think it should be, and quite prominently.

Breaking down your investment into your two purchases is telling. According to Smartshares’ calculations:

• Your first investment, of more than nine years, has an average annual return of about 5 per cent.
• Your second investment, of about six years, has an average return of almost nil, even with dividends reinvested.
• Your over-all calculation of about 2 per cent a year is about right.

Why the big difference for the two investments? Returns between February 2005 and August 2008 were a fantastic 12.4 per cent a year. But the timing of your second investment, in August 2008, couldn’t have been worse.

The global financial crisis started right after that, and shares around the world plunged. While many markets have grown well since then — including the Australian market — the fall of the Aussie dollar against our dollar has cancelled out that growth for SmartMozy.

What can be learnt from this? Firstly, share investments should be for at least ten years. Secondly, be aware of foreign exchange risk. If you had put half the money in a New Zealand share fund, you’d have done much better.

Thirdly — and this is important — it’s usually better to gradually drip-feed money into a share investment. Nobody knows whether now or the future is a better time to buy. So if you spread your purchases, you’ll at least have bought some at what turns out to be the best time.

Smartshares has a plan enabling people to gradually buy into their funds, contributing $50 or more a month after they’ve bought a minimum number of units.

But that’s too late for your investment. What should you do now, assuming you want to withdraw the money in three or four years?

With that time horizon, conventional wisdom says you should move the money now to high-quality bonds or bank term deposits. It should then grow slowly but steadily, safe from further share market or foreign exchange movements when you have too little time to recover.

Does that sound reasonable? Or are you saying, “Hey, I’ve had rotten luck so far. I want to leave at least some of the money in SmartMozy in the hope that it’s my turn for some good luck!”?

That’s understandable — as long as you appreciate that markets don’t respect fairness, and your bad luck could continue. If you do want to stick partly with SmartMozy, I recommend you plan to gradually move the money to bonds or term deposits. In the same way that dripfeeding into shares works well, so can dripfeeding out again.

Oh, and good on you for setting money aside for your grandsons.

AAs I said above, nobody ever knows when it’s a good time to buy into any sort of share funds — index or otherwise — despite lots of people’s claims. So dripfeeding your money in, perhaps over a year or two, is a good idea.

You can also reduce risk by:

• Investing only money you don’t plan to spend for ten years or more.
• Spreading the money into international index funds as well as New Zealand ones.

Hang on a minute. Didn’t the correspondent above lose money because he invested overseas? Yes, but you can also gain from foreign exchange movements. And by investing some of your money beyond New Zealand, you reduce your exposure to just one share market.

Thanks for your postscript. I should add that I don’t make any money from the website, so I’m not trying to plug it here!

ALabour’s finance spokesperson David Parker replies: “Gains on the principal family home are not taxed. Gains on investment property after the date of introduction are only taxed when realised.

“The details around the unusual situation described would be determined by the expert advisory group. We expect similar issues will have been considered overseas.”

In this context, “realised” means “made real” or “converted into cash”. In most cases that simply means “sold”.

ANo, and I don’t think it should.

The logic behind the current law is that many of us pay tax on income we earn from working, receiving interest and so on. So why shouldn’t someone who earns income from buying and selling assets at a profit also pay tax?

The trouble is that people also buy and sell for other reasons. A couple might plan to own a rental property their whole lives, live off the rents, and leave the property to their children. Their intention is not to sell at a profit.

However, if the couple unexpectedly find they need more money and so they sell the property — and it happens to be for more than they paid for it — the thinking goes that the gain shouldn’t be treated as income. They’re not traders.

Under your proposal, if they had to sell soon after they bought they would be taxed heavily. Meanwhile, someone else could earn a living by holding property or shares for six years and then selling, and pay no tax.

There’s another issue, too. If we went with your proposal, people would hold onto assets for longer than they otherwise would. Whenever tax law distorts the way people behave, it hurts economic growth.

AThere are two possible explanations. Firstly, anyone can transfer any amount into KiwiSaver — perhaps other savings, or an inheritance or bonus. Many people don’t do that because the money is usually tied up until they retire. But that wouldn’t be a problem for last week’s reader who would soon gain access to the money.

Secondly, although she’s retired now, she may have been working until recently.

When KiwiSaver started, employees had to contribute 4 or 8 per cent of their pay. While the minimum contributions have changed several times since, the reader may have kept her contributions at 8 per cent, in which case her account would have grown fast even if she wasn’t on high income.