Mary Holm: KiwiSaver - growth fund or cash?

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COMMENT:

Q: My mum had her KiwiSaver in a growth fund, and last week she changed it to a cash fund after seeing a loss of $20,000 as a result of the Covid crisis. I told her, "Listen to Mary before you do anything", but she didn't.

Now that I have shown her all of your warnings (after months of tirelessly suggesting your podcast) it is too late, the damage has been done.

She and my stepdad (who didn't bother to change) are only 36 and 37. They own their own home and therefore will not be touching KiwiSaver for another 30-odd years.

The question now is: should she quickly change back to the growth fund and cut her losses, or just sit tight in this new fund?

PS. I'm 21, I'm investing, I'm paying off my car loan ASAP and I listen to the RNZ Your Money podcasts religiously. I also went out and got Rich Enough? the other day. I love it.

A: This makes a change from parents worrying about their children's finances. And the next letter is about a young man trying to educate his dad. They go with the theme of adult children scolding their parents for being too slack about self-isolation. I love it!

The good news is that there won't be too much damage if your mum moves back into her growth fund fast.

As it happens, the New Zealand and world sharemarket indexes have tended to inch up in the past week or so — at least by my deadline time. So your mother may miss out on a small gain. But that's minor.

It's much more important that she doesn't miss out on what's sure to be a better performance in her growth fund over the next 30 years.

Do warn her, though, that the growth fund will fall again sometimes — perhaps even the day after she switches back. She must ignore the downturns. In investing — unlike in most other activities — negligence is good. Your stepfather had it right.

By the way, well done you! There are not many 21-year-olds who are so "together" financially — especially when they didn't pick it up from their parents.

Do-nothings win

Q: I've just read your article of last week that mentions, "I've seen many studies over the years comparing the average investor who moves their money around with the one who buys and holds. The latter always wins."

Could you please name a couple of studies? I am having a lot of trouble explaining it to my completely property-based father.

A: Let me just say first that I was writing about the average "mover". I added, "Sure, a few movers will outdo everyone else for a while, but that's just luck. They get overconfident and try it again — and lose."

Okay, now some research that shows this:

• Brad Barber and Terrance Odean of the University of California looked at the trading of more than 60,000 US households through a discount broker from 1991 to 1996.

The average household return was 15.3 per cent. Sounds great, but in that buoyant period the market gained 17.1 per cent.

This is old research, but it's particularly interesting because Barber and Odean also found that the more people traded, the worse it was. The fifth of households that traded most gained only 10 per cent a year.

• More recently, a US independent research firm called Dalbar has regularly looked at how the typical investor in US stock funds has performed compared with the S&P 500 market index. Each year the results are similar.

In the 30 years to the end of 2019, the investor made 5.04 per cent a year, compared with 9.96 per cent for the index. That's a huge difference. Starting out with $10,000, the investor would end with $45,000 while the index would end with $196,000.

It's true that in an S&P500 index fund, your performance wouldn't be as good because of costs. But you would still easily beat the average investor.

Says Dalbar president Louis Harvey, "Our research consistently shows that the average investor has displayed a strong tendency to sell at just the wrong time whenever there's a lot of sudden market volatility."

Online you'll find other research that suggests traders can do well. But check who is saying that. It's always people who gain from others' trading. I've been watching this for decades.

The last word goes to Wikipedia on "market timing": "Studies find that the average investor's return in stocks is much less than the amount that would have been obtained by simply holding an index fund consisting of all stocks contained in the S&P500 index."

What's its source for this statement? No fewer than five pieces of research. You or your dad might want to look them up.

Get into KiwiSaver

Q: We have just been granted the Permanent Residence Visa in NZ and so we can enrol in KiwiSaver. But, would it be wise to start investing now that the sharemarket is down, or should we wait a few months when the coronavirus outbreak is over?

A: Get in now. Nobody knows whether the markets will fall further. But in the long run — and possibly the short run — they will recover. You might as well be in for that recovery.

Invest or wait?

Q: I am wanting to begin investing outside of my KiwiSaver. I have $5000 to start with and will make ongoing contributions in a growth fund, or ETF, as it is for the long term.

With the markets being so low at the moment, is it better to wait until things recover a bit before starting out?

A: Like the previous correspondent, you shouldn't wait. You're contributing regularly, so if the markets continue downwards for a while, think of it as buying at low prices!

I saw some data recently on the 10 biggest falls in the US S&P500 index since the 1987 crash. The falls ranged from 22 per cent to 8 per cent, and the time it took for the index to recover ranged from just one month to 21 months. An interesting feature: there was no correlation between the size of fall and the time to recover.

A few weeks — or a few years — from now, you'll be glad you moved.

Deferring the mortgage

Q: Email from NZ Bankers' Association: We'd welcome your thoughts on the pros and cons of deferring mortgage repayments. That might help people considering this to work through their options and what it means for them financially.

A: While you're not calling this a mortgage holiday, most people are. And that's a worry.

Last year, the Government switched from KiwiSaver "contributions holidays" to "savings suspensions" because "holiday" has too many good connotations. For the same reason, I'm going to use your term — mortgage deferrals.

The deferrals, being offered by all retail banks, let people skip mortgage payments for up to six months if they're in financial trouble because of Covid-19.

But you don't get something for nothing. You'll still be running up interest on the loan, so it will be growing. Years down the track, you'll be repaying the mortgage for longer and paying more total interest.

I'm not saying don't take advantage of a deferral if you need to. But most people will be spending less for the next while — on travel, entertainment, clothes, hair and so on. And I hope most have rainy-day money to draw on.

So even if your income drops, do your best to make mortgage payments for as long as you can. And if you must take a deferral, try to do it for fewer than six months.

A halfway option is to switch to paying interest-only for a while. At least, then, your loan won't be growing. How much difference this will make depends on how long you've had the mortgage.

If you have the usual "table" mortgage — with the same repayments throughout, apart from interest rate changes:

• In the early years your payments will be largely interest. Switching to interest-only will make little difference.
• In the later years, your payments will be largely principal. Switching will make a big difference.

Statements from your lender should show how much of each payment is interest. Or ask the lender.

Your lender might also allow other options, such as extending the term of the loan from, say, 20 or 25 years to 30 years. The mortgage calculator on sorted.org.nz shows you how this will reduce your payments.

However, when things come right, please move back to your current mortgage payments. The sooner you get rid of your mortgage, the sooner you can start serious retirement saving, and the more fun you can have as an oldie.

Bank on it

Q: It would be good for readers to understand how the banks treat ordinary deposits compared to term deposits on their balance sheets.

Perhaps you could confirm whether depositors and term depositors are both creditors with the same liability for the "haircut" if a bank gets into difficulties?

A: As explained last week, under Open Bank Resolution (OBR), if a bank failed, a portion of all types of accounts would be frozen, and you may not get all that money back later. Each account might suffer a "haircut".

On your first question, a Reserve Bank spokesperson says, "Depositors, whether they have on-call transactional accounts or term deposits, belong to the same class of liabilities with the same exposure to the haircut (that is, in terms of proportion of funds frozen) if a bank gets into difficulties and OBR is applied."

However, a "de minimis" amount in on-call transactional accounts such as cheque and savings accounts wouldn't be affected, so that people could get on with day-to-day transactions and the bank would stay open.

"Does that mean," I asked, "that someone with tens of thousands of dollars in a bank would be better off moving all the money into various on-call accounts?" You would get lower or no interest, but these days interest rates are really low anyway.

The Reserve Bank declined to give financial advice. But, the spokesperson said, "Please also note that OBR was designed to enable depositors to access a good portion of their funds (remaining after the application of the de minimis and haircut). In the absence of OBR, depositors would wait for the liquidation of the bank's assets to access their funds.

"The de minimis amount is currently unspecified but is expected to be around $500 to $1000 on transactional (on-call, chequing) and savings accounts, on a per account basis."

It doesn't seem worth rearranging your accounts. In any case, an OBR does not look imminent.

"Open Bank Resolution can only take place on the recommendation of the Reserve Bank with the agreement of the Minister of Finance," says the spokesperson.

"This recommendation is made only in the extreme case when a bank has failed (for example, it is insolvent or unable to pay its obligations) and options have been exhausted to resolve the bank's problems.

"The Reserve Bank maintains a close watch on the financial system, and wishes to stress that the New Zealand financial system remains safe and sound."

More on this topic next week.

- Mary Holm is a freelance journalist, a seminar presenter and a bestselling author on personal finance. She is a director of Financial Services Complaints Ltd (FSCL) and a former director of the Financial Markets Authority. 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 mary@maryholm.com. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.