Forum Archive Index - February 2002

["tennyson@caverock.net.nz" <tennyson@caverock.net.nz>]

Having had my general rant on this topic, I wanted to go over a 
specific example which will show why the Risk Free Return Method 
(RFRM) formula is such a bad thing for small investors, and 
ultimately, for the country.

Here is the dreaded formula again for those who have forgotten it:


-----------

Net asset value at the start of the year
                  x
Statutory risk-free real rate of return
                  x
        The investor's tax rate

------------




I'll use the US market as an example.

Suppose an investor has some money invested on call in the United 
States just waiting for the right moment to purchase some shares.

Our government decides that based on NZ government stock rates the 
risk free return rate that all investors should be earning is 5%.  

Now, US interest rates are far below this level which means that 
there is no way a fixed interest investor in the US can ever meet the 
government's target return.   Yet the proposed law is that this same 
investor will pay tax assuming he had earned 5%, *regardless of his 
actual income earned*!

I would say our hapless investor will be fairly disgusted with having 
to pay tax on a hypothetical amount of income far greater than he 
actually receives!  Unless our investor can get a return of greater 
than 5% he is going backwards!  He panics, closes his US term 
deposit,  and buys into a NASDAQ index fund, hopeful of a 10% + gain 
per year that will see him 'in the money'.

But we have failed to address one critical question here: that is 
'Why are the interest rates in the US so low in the first place?'   
The answer is because the US economy is in a precarious position.   
So our hapless investor is pushed by our government to invest in a 
highly volatile overseas sharemarket fund at just the wrong time!   
There is a 20% correction in the NASDAQ index, and our hapless 
investor loses 20% of his capital.  

Even so the next year our own government comes by grabbing its wealth 
tax share of whatever fortune our hapless investor has got left, 
despite our investor's massive losses!   Thoroughly disgusted at 
being prodded into buying shares at exactly the wrong time, our 
investor pulls out of his overseas investments vowing never to invest 
in overseas sharemarkets again.  He buys a bigger house in Auckland 
instead, which thanks to Cullen removing the part of the tax reform 
package that would tax a person's own house, is indeed the most tax 
efficient use of his money.

People pulling out of their overseas investments and buying property 
in Auckland.  This will be the legacy of the proposed Cullen scheme. 

SNOOPY



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