KEY POINTS:
I feel that many people outside the finance and investment industry are behind the eight ball when it comes to sifting through the investment advertisements in the daily papers and determining the good from the bad. So I have prepared some guidelines.
Investors should stay away from an investment company whose advertisement contains one or more of the following:
* A picture of a Corinthian column.
* A picture of a statuesque lion or other jungle beast.
* An endorsement from a famous New Zealander or television "celebrity".
* A rate of interest several percentage points higher than the major banks.
* A name that sounds vaguely familiar and for some reason puts you in mind of august European or American financial institutions (apologies to genuine august European and American financial institutions).
* The words "first ranking secured debenture stock".
* Asterisks and small print.
* Exclamation marks.
* A credit rating from anyone other than a major recognised agency.
* A credit rating from a major recognised agency that starts with a letter other than A. (Just because you were happy with a B in your school maths exam doesn't mean it's a good credit rating.)
Brilliant. This would, of course, rule out some good investments. But certainly the more ticks an ad gets, on your list, the more people should worry.
To elaborate on a couple of your points:
* If an investment is offering a return considerably higher than the banks, the investment must be riskier. Why else would someone be willing to pay you that return?
* On any investment that is "secured", check what it is secured against. Sometimes, the security doesn't end up being worth much at all.
* Some investments with high B ratings are fine. But, just as with higher returns, lower ratings are a sure sign there's risk involved. Make sure you could cope if the investment went bad.
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I would like to clarify one point, which occurred to me in relation to the first letter in your column last week and the accompanying graph of Tower Tortis returns.
I presume the graph shows nominal dollars (dollars of the day) and not real dollars (dollars corrected for inflation).
Similarly, when one observes that "one is unlikely to lose value over a 10-year period from a well-diversified share investment", this comment is made when nominal returns are observed. Is this so?
Inflation has been relatively low for 15 years, but even at 2 to 3 per cent per annum, the picture of real returns can be quite different from the picture of nominal returns.
I suspect a lot of people, including investment analysts, do not make this distinction.
I don't just suspect, I know you're right. The graph and words last week were, indeed, in nominal dollars - not adjusted for inflation.
There's a strong argument for using real dollars. A thousand dollars today will buy only $740 of goods and services in 10 years if inflation is just 3 per cent.
The trouble is that practically everyone discusses investments in nominal dollars. If I use real dollars, readers will find it hard to compare numbers. Some will even struggle with the whole concept - and that can be a big turnoff in a weekend newspaper. I faced a similar problem back in 1987, when I was business editor of the soon-to-be-launched Auckland Sun. The Dow Jones index has always been the most quoted US share market index, but it doesn't reflect market movements nearly as accurately as the broader S&P500 index.
In the hope that it would catch on, we gave prominence to the S&P500. It didn't work. The Dow Jones is still the most quoted index. No doubt that was partly because we were just one newspaper, which lasted less than a year. But in any case, it's always hard to change ingrained habits.
Still, you make a really good point. We all need to keep the effects of inflation in mind all the time.
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I quote from last week's column: "International shares have never fallen over a 20-year period." Where did you get this from?
I am disappointed that you too have fallen into the trap of believing that holding diversified stock for 10 years will almost certainly provide a positive (ie, I assume real) return.
This is simply not true. According to data in Robert Shiller's Irrational Exuberance, there are many periods where an investor will not receive a positive real return after 10 years.
The worst cases (yes plural) show that for two periods totalling 50 years last century, real prices took about 25 years to return to their previous levels. A bit tough if that coincides with what many would consider a long-term super saving period!
What I think this really highlights is the importance of the implementation of an equity market strategy. Just considering a single lump sum investment in any equity market is just plain dumb.
Regular and continuous investments over a long period are the only way one should ever think about an equity market savings programme. Then and only then can one make the claim of near-certain positive returns over a 10-year period.
While the previous reader assumed I used nominal dollars, you - wrongly - assumed I used real (inflation-adjusted) dollars. That's the difference between Shiller's numbers and mine.
Shiller's data cover 1870 to 2000, during which there were extended periods of high inflation in the Western World. Adjusting for inflation in those periods had a big impact on the performance of any investment, including shares. In these lower inflation times, the difference isn't so big - although, as noted above, it should still be considered.
But the main point, I think, is that of all the major types of long-term investments, shares are the riskiest and therefore bring the highest average returns. Property has lower risk and lower average returns - unless you borrow to invest in it, which most people do. This gearing raises both risk and returns. So let's consider here both shares and geared property.
We could dwell on the fact that the inflation-adjusted returns on shares are sometimes negative over long periods. And on geared property, inflation-adjusted returns over shorter periods can be a nightmare. But where else should people put their savings? In other investments likely to perform even worse after inflation?
At least the values of shares and property tend to rise with inflation, giving people some protection.
You're quite right that it's less risky to invest in shares regularly over a long period than in a lump sum. With regular investment, you sometimes buy when prices are high and sometimes when they are low, making long-term gains more likely. Still, if somebody has a lump sum and wants to invest in shares, I wouldn't advise them to spread that investment over more than, say, a year - unless they are really risk-averse.
Because shares outperform the alternatives more often than not, most times investors will do better having all their money in the market than holding some back. If, however, they would be really upset to see their investment drop soon after they invested - perhaps to the point of committing the sin of bailing out in a slump - spreading the investment over several years may be their best strategy.
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I refer to the recent reply regarding the new overseas tax legislation from Inland Revenue, which stated that the Aussie exemption doesn't include companies that are not resident in Australia, even if they are listed on the Australian stock exchange.
As it may not be readily apparent that an Australian listed company is not an Australian resident, is Inland Revenue going to provide such a schedule on its website, which will ensure that taxpayers can comply with the new legislation.
For example BHP Billiton and Rio Tinto are dual listed in Australia and Britain, but are they resident in Australia? Also Rinker's main business is in the United States, but is it resident in Australia?
Inland Revenue is being unfair, if it leaves it up to the taxpayer to determine a company's residency.
Inland Revenue has no plans to publish such a list.
But, says Peter Frawley of the department, "If a person receives a dividend from a company listed on the Australian stock exchange that carries Australian franking credits (this would be stated on the shareholder dividend statement that the person receives from the company) then this should provide sufficient certainty that the company is resident in Australia."
He adds that "it has been a requirement for many years with the current Grey List exemption for a person to know whether the companies they invest in are resident in Grey List countries (Australia, United Kingdom, Germany, Norway, Spain, United States, Canada and Japan)".
I think Frawley is politely trying to tell you the new rules will be easier than the old ones, so what are you moaning about!