Mary’s Q&A column appears in the Business section of the Weekend Herald. Mary was a finalist for the "Best Columnist – General" award for this column in the 2014 Canon Media Awards.
NZ Herald 14 October 2017
Q&As: Should teacher buy in Whanganui now so she can move there later?
- Reader gets it wrong about share market index
- Mixed bag of comments on shares v rentals
Question: I am a 55-year-old teacher, but would really like to do something else and work part time.
I own an old council flat that, due to its central Auckland location, is worth $750,000. I have paid off my mortgage.
Some friends are selling up and moving to Whanganui, and I am considering it in the longer term.
I see a house to buy near the sea in Whanganui at $170,000. I have a $40,000 deposit, and rented out it will bring $250 a week. I could afford to do this now. I don't have fancy tastes so that would suit me.
I want to travel more and would look at moving to Whanganui in about five to ten years. I have some health issues - hip replacements that will need redoing - and I expect that I will need to fund these myself as the health system is under so much pressure.
Is it best to just save money and not buy a house?
Also, if a capital gains tax comes in - which I actually support - and I sold my Auckland flat, that would impact on it I think.
Anyway, your thoughts would be appreciated. I want to live my life fully now as I expect my health to not be great as I age.
Answer: There's a lot to be said for getting into a particular property market now if that's where you want to be in a few years. It removes the risk that prices will rise fast between now and then.
The exception, of course, is if there's a good chance that prices will fall - as in the current Auckland market.
What about Whanganui? House values in Whanganui District seem to lag behind the national average.
In the year ending September 2015, they barely changed, while nationwide prices grew more than 12 per cent, according to QV. But the following year, Whanganui's 12 per cent growth almost matched the nation's 14 per cent. And in the past year Whanganui prices grew more than 13 per cent, while the nation's growth dropped to 4 per cent.
Will Whanganui prices start to stabilize soon too, and possibly fall?
Nobody knows. But Whanganui prices still average only $230,000. And given the increasing tendency for Auckland retirees to move to attractive towns elsewhere - often freeing up half a million dollars or more - it seems unlikely that Whanganui prices are in for a big slide.
- Can you afford to buy that house? Payments on a 20-year $130,000 mortgage at 6 per cent would be $430 a fortnight. On a 30-year loan they would be $360 a fortnight.
Then there are rates, insurance and maintenance. And I would recommend you get someone local - maybe a friend who has moved there - to manage the property. It's too hard dealing with property problems from afar.
So you may have to inject other money. Can your income cover that, plus travel?
- What about possible hip replacements? Ask the mortgage provider if they would be willing to increase your loan to pay for that. That might be okay, given the proceeds you will get from selling your flat.
- How might a capital gains tax affect you? Politicians always rule out taxing gains on people's own homes. But landlords might be taxed on gains made on a rental if they moved into the property themselves.
Still, I doubt if such a tax would apply to properties already owned when the new regime started - or if it did, it would be at a pretty low rate. I wouldn't let this worry you.
- Would you be better off just continuing to save? This is another "nobody knows" situation. But it feels to me, reading between the lines, that you would like to buy in Whanganui. It would give you a grand plan. If you've got enough income - see the first bullet point above - go for it!
Question: I believe your graph two weeks ago of shares and real estate doesn't tell the whole story.
For many "once hurt, twice shy" share investors, the massive gains don't ring true. This is because of the "survivability bias" in share market indexes. As one company starts to decline, a rising star is substituted, and that makes the index look far better than the market really is.
To allow for this, major fund managers often confine their share composition to members of an index, discarding their fund's poor performers which have become excluded from it. But Mum and Dad investors often don't react to an index down-grading.
Real estate almost never goes to zero in value (i.e. without an insurance payout etc), but shares often drop significantly or sometimes die altogether, as happened in 1987 to 89.
During bull markets after a crash, share brokers typically go from lamenting the absence of retail investors for the first few years, to expressing their confidence in the markets by saying, "It is time in the market, not choosing when to buy, that is important." Or, "The index has risen by x per cent over y years, so you should make the trend your friend".
These statements are, more often than not, right. But sometimes they can be badly wrong, and the investor loses. It is for the share investor to exercise reasonable judgment and question their broker about ways to minimise their risks.
Answer: I think you've got "survivor bias" wrong.
The term usually applies when a researcher looks at, for example, actively managed share funds versus index funds over the last ten years.
The active funds exclude those closed down during the period because they performed badly. So the average performance of the active funds is biased upwards.
This is something everyone should watch out for. When an active fund manager - including many KiwiSaver providers - points to their great performance over time, they often forget to mention their dog funds (no offence to canines) that quietly disappeared. Index funds, on the other hand, don't close because of bad performance.
In the context you're using "survivor bias" though, the dropping of declining companies from a share index is matched by the absence of rising companies before they are big enough to get into the index.
For example, in the graph two weeks ago, we used the S&P NZX50 gross index, which basically covers the biggest 50 companies. If Declining Co's share value drops so it's no longer in the top 50, and then it keeps dropping - perhaps to zero - you're correct that the second phase of that fall isn't reflected in the index.
But meanwhile the small Rising Co has been listed on the market. Its share price has to climb a long way before it enters the index. And that spectacular rise isn't reflected either.
Our graph today proves my point. It compares the growth of the S&P NZX50 gross with the S&P NZX ALL gross index, which includes all the ordinary shares on the main stock exchange.
The two move closely together, because the big shares dominate the All Index. But note the difference between the two lines. In most periods the All Index grows faster than the NZX50. This is because the smaller shares that it includes tend to be higher risk and usually bring higher returns.
The absence of Rising Co in the NZX50 until it's big enough more than offsets the absence of Declining Co once it has dropped out of the NZX50.
Contrary to what you say, the NZX50 doesn't "look far better than the market really is". The NZX50 actually understates total market performance.
On your other points:
- If Mum and Dad investors don't follow the markets closely - if that's a wise strategy anyway, which is debatable - they can invest in an index fund. They will benefit from broad diversification and low fees, and none of their holdings will go to zero.
- I've said over and over how important it is for share investments to be diversified and for ten years or more. That way you don't get burnt badly by a crash, as the market always recovers.
- The first share brokers' saying, about time in the market, is correct. What's more, it works much better to drip feed money into shares rather than trying to pick when to buy. But the second saying, about making the trend your friend, is dangerous. A trend can change at any time.
Question: My followup 'questions' and comments on shares v houses are as follows.
The S&P NZX50 index is not necessarily the best indicator for share returns for a typical retail investor, as some of the worse performing shares often are dropped out of the index, replaced by better performing ones.
While index funds are available, it would be helpful to indicate fees in the calculations.
Worth commenting on the taxes being applied to the two options, including negative gearing and tax offset against personal income tax in housing investment.
Stock selection and/or the choice of managed funds can significantly limit risks in shares along with diversification. Morningstar reports over the long term have demonstrated performance and risks are not always correlated. Just have to find the one (or two) outliers that had a much better return at a given risk. There are PIE funds never made an annual loss, and yet returned an average double digit annual return in the last 10 years.
Finally, calculating overall absolute net return would be more interesting, from an initial investment of say $20,000 in shares versus a $20,000 deposit into a $100,000 house?
Answer: Where did this incorrect notion come from - that has caught both you and our previous correspondent - about how good and bad performers affect the S&P NZX50 index?
Anyway, I agree it would have been better to use the S&P NZX ALL gross index in our graph two weeks ago, but we don't have data going back far enough. Interestingly, as stated above, that would have made share performance look better.
You're right that if we were doing a rigorous analysis of rentals versus shares, we should look at fees and tax. But, as I've said before, there's no good data on a typical rental property investment.
Your mention of negative gearing illustrates that point. Some landlords negatively gear - with rent not covering all expenses - but others don't. And some do it in a much bigger way than others. Which is typical?
Then you say that you "Just have to find the one (or two) outliers that had much better return at a given risk." If only that worked! Investing in funds with a great past performance is highly risky. Past top performers are quite often poor future performers.
I like your idea of the $20,000 comparison - if we could all agree on assumptions. But as I said last week, the results would depend so much on which set of reasonable assumptions are used.
More letters on shares versus rentals next week.
* Mary Holm is a freelance journalist, a director of the Financial Markets Authority and Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. Her website is www.maryholm.com. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary's advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to firstname.lastname@example.org or Money Column, Private Bag 92198 Victoria St West, Auckland 1142. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice.