Money Matters: 'Diversify' the best option

By MARY HOLM

Q. At the age of 40 (about a year ago), I decided that it was time to get serious about sharemarket investment. Since then, I've read everything that I can, including your column, and reached these conclusions:

* Given New Zealand's progress over the past couple of decades, and globalisation, the NZ dollar may continue to depreciate.

* A realistic return on the sharemarket is about 5 per cent net over the long term.

* World sharemarkets are at historically high and probably unsustainable levels.

* Imputation credits are a big plus for New Zealand sharemarket investment against overseas shares, albeit that the latter don't have high dividend yields anyway.

All of which suggests that a rational strategy would be to invest in quality New Zealand companies that offer imputation credits, are protected against a fall in the dollar through overseas exposure and are at very low price to earnings (P/E) ratios compared with overseas companies. Then, when overseas markets collapse/plateau, gradually crank up foreign exposure.

In pursuit of this strategy, I hold WestpacTrust, Tower and Contact shares. In time, I will add Telecom and others to my list.

So the question is: Why do New Zealanders want to buy foreign shares at P/Es of 30-plus, yields of 1-2 per cent, no imputation credits and the likelihood that while our dollar may continue to decline in the long term, it is, in the short term, at low levels, and therefore entry prices are very high?

I know all the arguments about foreign growth etc. But right now it seems to be a strategy with substantial downside risks.


A. Buying foreign shares, or any shares, always has substantial downside risk - but often substantial returns to go with it.

Whether the foreign share risk is greater now has been widely debated. Many say that overseas share prices have soared because of technological changes and globalisation, and will from now on fluctuate within a new, higher range.

Only time will tell if they are right or if, as you put it, the prices are unsustainable.

Looking at your other conclusions, I agree with the second and fourth ones.

Your first one is more of a concern. Our dollar is where the collective wisdom of all the big players in the market puts it. I certainly wouldn't make any moves based on an expectation that it will rise or fall.

In any case, you seem to be arguing on both sides. You also say that our dollar is currently "at low levels" so that entry prices of foreign shares are high.

But if you think that the kiwi dollar will sink further, that would push foreign share prices even higher - unless overseas markets do, indeed, collapse. If they don't, and you wait before going offshore, you lose out.

Your plan is based on several predictions that, quite simply, might not come true. You're trying to time the market. Too often, that's a losing proposition.

Meantime, you're not using a powerful tool: diversification.

Generally, risk and expected return are closely related. Both are high or both are low.

But with a widely diversified portfolio, you lower your risk without reducing your expected return. It has been described as the only free lunch in investment.

Three, or even half a dozen, shares are too few for a diversified New Zealand portfolio. And you're missing out entirely on the advantages of investing in the rest of the world.

In a global share fund, when one economy or industry is doing badly, another is doing well. The path is smoother. There's much less chance that, when you want to get your money out, you'll do so at a loss.

By all means keep some of your money in New Zealand shares. You'll benefit from imputation, and no foreign exchange risk.

But if you've got a New Zealand house and New Zealand job, you're already "seriously overweight" in New Zealand, as the experts would put it.

If 25 per cent of your shares are local, that's plenty.

Q. What would you advise as the most cost and tax-effective way of raising money to build a new home on a mortgage-free section we own, before selling the house we currently occupy.

We are retired and have a managed (moderate) portfolio of $600,000, from which there are no regular drawings of capital. The combined value of our present home and the section we propose to build on would be about $700,000. Should we:

* Raise a short-term mortgage against the properties to cover the entire building costs? We would repay the mortgage on the sale of the first property. (Mortgage repayments in the meantime covered by portfolio withdrawals.)

* Withdraw the total building cost (say, $300,000) from our portfolio, and reinvest it when able?

* Finance the building costs by withdrawing some portfolio funds and raising a mortgage for the balance?


A: This is an interesting variation on the more common question: should I invest or repay my mortgage?

In your case it's: should I "uninvest" or get a mortgage?

But, in theory at least, it boils down to the same issue. If you keep your investments and get a mortgage, can those investments earn more, after tax, than the interest you pay on the mortgage?

I'm assuming that your "managed (moderate) portfolio" means investments in a fund or funds that hold some fixed interest and some shares.

In a good year, the after-tax return on those investments might well be more than the mortgage interest. But in a bad year it won't.

Your mortgage payments, though, will be a fixed amount on a fixed date. The amount going out is certain; the amount coming in is not.

While it wouldn't be a disaster for you to eat into your capital to meet some mortgage payments, you would be losing ground by doing it.

It would seem, then, that you should go with your second option.

Note, though, that I said "in theory" back there. There's a timing factor in your situation that could turn everything upside down.

If you get a mortgage, it will grow only gradually, as the building of your house progresses. And you are certain that you'll be able to repay it when you sell your present home, perhaps in a year or so. You won't be heavily in debt for long.

If, instead, you sell some of your investments and then go back into them about a year later, you not only miss out on returns in the meantime but may pay exit fees or brokerage and, almost certainly, re-entry fees or brokerage.

Those "in and out" charges could eat quite heavily into your portfolio. Find out what they would amount to, and compare them with the fees, legal costs and so on of getting a mortgage. If the mortgage costs are considerably lower, I think you should go the mortgage route. And a long-term or interest-only mortgage might be best.

That way, the payments will be smaller, so you'll do less digging into your portfolio to meet them.

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