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Weekend Herald

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 October 29 2005

Q&As: Should immigrant solo mother get into the housing market now?
What is an index fund?
How exchange traded funds work.

Question: I am a single woman aged 41, with one dependant aged 13. I came to New Zealand about four years ago with my child and a suitcase.

Her father, who permanently resides abroad, refuses to pay child support, so I rely solely on my salary.

I currently earn just under $55,000 a year. I have a second job that brings in an additional $5000 a year. However, this is dependent on the availability of work.

I have no debts or hire purchase and manage to pay for my credit card on time. I currently rent an apartment paying $1000 a month.

My question is how best can I invest for my future? I have saved about $20,000 to date, and I am keen to look at investment options. I am looking at the property market, but repayments are steep.

Am I on the right track or should I be looking at other options considering my age?

Answer: You're not just on the right track, you're doing really well, given that you started from scratch four years ago.

Many people would save nothing in your circumstances. And it's great that you have no debt.

Buying your own home - perhaps a modest apartment or unit - is a good goal. It will give you and your daughter security. But is now the time to buy, or should you wait a while?

Generally, it's foolish to try to time the property or share market. People get it wrong too often, and pay high transaction costs getting in and out of investments.

Right now, though, property has risen extraordinarily far, and many people expect prices to fall at least a little - especially for apartments. Also, rents these days are unusually low relative to prices.

Another thing: you haven't got enough savings for much of a deposit and an emergency fund. If you buy a sound apartment, you shouldn't incur too many maintenance costs. But it's good to have, say, $10,000 just in case.

Over the next year or two, you can boost your savings and, with luck, watch apartment prices falling.

If you could then buy a small apartment with a $100,000 30-year mortgage at the current five-year fixed rate of 7.5 per cent, you would repay $700 a month. Even if the rate has risen to 9 per cent by then, you would pay $805 a month.

Compared with your current rent payments, that leaves $200 or $300 a month to go towards rates and insurance.

You might baulk at a 30-year mortgage in your forties. But once your daughter is independent, you should be able to pay it off faster.

Another possibility: Get a bigger mortgage and pay interest only while your daughter is still with you. Once she leaves, switch to principal and interest.

All the best. You've obviously got the determination to make it all work.

Question: You recently talked about index funds on Face to Face on TV One.

I was wondering if you could give me further information on the subject of index funds in New Zealand.

Answer: I'm happy to, as I think they are an excellent way for smaller investors to own shares.

Index funds - sometimes called passive funds - invest in the shares in a sharemarket index.

They are cheap to run, as they trade infrequently and the fund manager doesn't need to do research on which shares to buy and sell. Because of this, their fees are lower than on actively managed share funds - which makes a big difference to returns over the years.

And generally speaking, they perform as well as, or better than, the average active share fund.

Several fund managers and employee super schemes offer index funds. Some are traded on the stock exchange, and most of those ones are run by a subsidiary of NZX. For more on this last group, read on.

Question: I bought some Fonz shares when they were first offered. They are the only shares I own.

NZX's marketing for the offer targeted novices such as myself by promoting a passive, market-tracking product giving diversification. But going by their performance so far, NZX's marketing seems far from accurate.

In the six months to June, NZX data show that Fonz shares underperformed the index they supposedly follow, as did other passive NZX products.

At the end of the day they are just another share (among many). If people don't want to buy them the price will fall.

Their success will surely depend at first not on the performance of the sharemarket segment they supposedly track but their acceptance by New Zealanders.

At present they are thinly traded and consequently the purchase prices offered are below the so-called market value.

I understand that overseas such funds are popular with large institutional investors. I would question if it was a wholly responsible move to encourage 'mum and dad' novice investors to purchase such an untested concept for NZ.

Answer: You seem to misunderstand a couple of key points about index funds.

New Zealand's first index fund, Tenz - which invests in the biggest ten companies on the stock exchange - was started by NZX in 1996, so I wouldn't call the concept untested. And US index funds have been around for decades.

There are now four Smartshares funds run by the exchange subsidiary: Tenz, Fonz, Midz and Mozy.

Fonz invests in our biggest 50 companies, with no company making up more than 5 per cent of the fund. This gets rid of the domination, in particular, of Telecom.

Midz invests in middle-sized companies, and Mozy invests in middle-sized Australian companies.

Index funds are expected to perform as well or badly as their index. And you're right that three Smartshares funds underperformed their indexes in the first half of 2005.

But in two cases the difference was small: 2.06 per cent for Fonz versus 2.10 per cent for its index; and 3.40 per cent for Tenz versus 3.42 per cent.

Such small errors are to be expected, because of rounding, slight delays in changing shares after index changes and so on.

Sometimes, the opposite happens. While Midz and its index both grew about 1.76 per cent, Midz was slightly ahead.

The fourth fund, Mozy, grew 1.44 per cent versus 1.52 per cent for its index, a somewhat bigger gap. However, says Smartshares director Geoff Brown, this was because of a timing difference that came out in the wash soon after.

All these returns are before dividends and fees. On Fonz, dividends added 2.95 per cent in the six months, and the fees range from 0.9 per cent for small holders to 0.4 per cent or less for large holders. After dividends and fees, the six-month return was 4.56 per cent or more.

While it's true that the units in these funds are in many ways "just another share", their price doesn't rise and fall solely because of supply and demand.

Exchange traded funds, such as Smartshares, operate under a system that keeps the unit price close to the value of the shares within the fund.

It works like this: Anybody can go to the fund custodian and swap some units for a "basket" of the underlying shares, or vice versa.

If the units are worth less than the shares, people can profit by swapping units for shares. This will push up the demand for units, and hence their price, until it is pretty much the same as the shares.

If the shares are worth less than the units, the reverse will happen, pushing down the unit price.

It's usually share brokers who make these transactions, says Brown, probably partly because they can do it without paying brokerage. About 25 or 30 Fonz transactions have been made in the last four or five months.

Through this arbitrage system, the fund ends up trading within 1 per cent of its net asset value - which is near enough, to my way of thinking.

Is Fonz thinly traded? Brown says about $290,000 worth of Fonz units are traded each month, and the fund has a market capitalisation (the value of all units) of about $28.6 million.

The shares in some other companies of similar size trade more often than Fonz; in other cases it's less often. Fonz is about average.

"Nobody has said to us that someone was wanting to sell Fonz and they were unable to trade," he says.

All in all, I think your worries are unfounded.

Like any other share investment, though, your Fonz investment should be for the long haul. If I were you, I would stick with it.

h Mary Holm's advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following her advice. Send questions to maryh@pl.net or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We wont 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.

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