By Roger Armstrong
Wednesday 1st October 2003
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Fools. Have they not been listening to the financial planners? Do they not realise that saving for retirement is a serious business best done with lots of professional help?
Well, luckily the average Kiwi saver has ignored the investment professionals and proved to be remarkably right. Housing has been the place to invest your money, especially by the beach or lake. Post September 11, New Zealand is arguably being rerated as a place to live. Expats are returning home, upper-middle-class Americans and Brits are discovering the splendid isolation of Wanaka, Asians are flooding here to learn English. At the top end the internet has also boosted the market through its worldwide reach into affluent markets. Broadband and improved video technology has helped. By contrast, managed savings products have done abysmally over the past five years. Blame lousy markets, the tech wreck, currency rise, whatever, but there is also a fundamental structural reason why saving the scientific way, as promoted by most of New Zealand's financial planning industry, is a recipe for mediocrity.
There is a school of investment thought that says diversification is overrated. The so-called Swiss axioms of investment include one piece of wisdom: "put all your eggs in one basket and watch that basket very carefully". Warren Buffett put it succinctly when he described diversification as a "hedge against ignorance".
Put another way, there is a case - not watertight, but arguable - to put most of your money into what you understand best. And New Zealanders - Aucklanders in particular - know the housing market upside down and backwards. Housing investment gets more dinner party airtime than the All Blacks.
Property also has the advantage that the banks are willing to gear investors 10:1 without blinking. You can gear into shares, but it is harder, more costly and takes more expertise.
The big question is, will property continue to run or will Don Brash one day be proved right in his legendary pessimism on housing investment?
In America there is an old saying regarding the sharemarket, that when the bellhop buys, it's time for smart investors to sell. In New Zealand there is anecdotal evidence that the unsophisticated have discovered the second house idea, and the proliferation of seminars on how to get rich through gearing into property is a worry.
It could be that the international rerating of premium New Zealand sea and lakeside property continues, but in the long run the rump of housing stock should move in line with rental rates, which should in turn move in line with incomes - around 2-3% a year.
That said, studies of housing over the past 10-20 years show annual returns including rental and capital gains of around 10-12% pre-tax, relatively similar to returns from the sharemarket.
Experts may criticise gearing into housing as an investment option, but there is also much to suggest that managed funds are not such a sensible option either. For a start, the tax system is loaded against managed funds in New Zealand. These funds have to pay or accrue capital gains tax on any appreciation in shares. By contrast, private investors in shares (or houses) do not have to pay capital gains tax unless they are traders, which most people are not.
On a managed share fund this tax impost is likely to cost roughly 1.5-2.0% per annum if the sharemarket performs averagely. On top of this, investors have to pay management fees and other associated costs. Some large overseas fund managers get their expense ratios down to around 0.3% but in the small New Zealand industry expense ratios for share trusts rarely fall under 1.5%.
In New Zealand it is not just investors in shares - which do require significant hands-on management - who pay such fees. Some diversified products - particularly superannuation funds - also have high fee structures, with investors effectively paying 1.5% plus annual management fees on low-returning assets such as bonds and cash. When interest rates are around 4-5% these costs take an enormous percentage of the gross returns. Upfront fees when buying into trusts, monitoring fees charged by financial planners and double fee imposts through umbrella trust structures further cut into returns.
Allowing for, say, 1% per annum for the above category of extras, it is possible that investors will pay around 4% or more in fees and tax on any share exposure, and anywhere from 1-2.5% on bond exposure. This is close to half the returns you would expect from these assets.
Investors who don't want to be hit by the tax/fees ambush can invest directly in New Zealand shares and fixed interest themselves. It is not a popular path in New Zealand currently, with private investors having a history of bad decision-making and a lack of knowledge of value investing. The sharemarket also gets bad press that it does not entirely deserve.
But, following the performance (and ongoing handicap) of managed funds, and given the increasing interest of taxi drivers in the property market, a DIY approach to financial market investment could be the next fashionable dinner party topic. It deserves to be.
Roger Armstrong is an independent financial analyst. Disclosure of interest: nil
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