Sharemarket turbulence can be unsettling but hang on for the ride. Photo / 123rf
Q: Phew, good thing I divested from KiwiSaver a little while ago, and went into bank term deposits.
A: Okay, I’ll admit your timing looks pretty clever! If stock markets were weather systems, the turbulence over the last 10 days would have grounded many planes.
But what next? Will you stay in TDs? Or, when world share markets resettle , which they inevitably will - although it might take some time – will you pop back into a higher-risk KiwiSaver fund that holds lot of shares?
I’m assuming you were previously in such a fund. Growth and aggressive funds are the hardest hit by downturns, and the ones you are most likely to feel smug about escaping.
Because of their volatility, those funds are suitable only for money you don’t plan to spend for ten years or more. But they are also the funds most likely to grow fastest over long periods – considerably faster than term deposits.
So, when are you going to switch back? By the time you’re sure the long-term upward trend is back, it will probably be too late.
Much research shows that remarkably often the worst days in a share market are closely followed by the best days. For example, in the 20 years ending December 2023, seven of the 10 best days fell within two weeks of the 10 worst days. And just this past Thursday, the NZ share market made its biggest gain since June 2020.
People who move in and out of share funds often miss those high-growth days.
Other research, by US-based firm Dalbar, found that in the 30 years ending December 2023, the average share fund investor earned 8.01% a year. Not bad. $100,000 invested at the start of the period would have grown to just over $1 million.
However, if they had invested in an S&P500 index fund – and stayed there – their average return would have been 10.15% a year. The $100,000 would have grown to more than $1.8 million. That’s a big difference.
Why did the average investors do worse? Largely because they got in and out of their investments, trying to time the markets.
I recommend you get back into that fund and stay put!
Footnotes:
Q: I am feeling let down by you and our country’s other financial columnists.
Whenever there is a crisis – Covid, the Russian invasion of Ukraine, or President Donald Trump launching his tariff war – the advice to mum-and-dad investors is always the same: sit tight and don’t panic. Don’t cash up and salt the money away in the bank; things go down but they always go up again.
Right from March 25, 2000, when Jacinda Ardern announced the first pandemic lockdown, I have followed this advice. I have kept my KiwiSaver money, for example, in the conservative fund I use because of my advanced age.
So let’s look at what has happened in the five years since that first lockdown. The price of my conservative fund units has gone from $1.7833 each to $2.0553 – an increase of 15.25%.
But inflation has been more than 22%. So have I not effectively lost money (in terms of its buying power) by sitting tight?
Was it wise for me to follow your advice? Would I not have been better to cash up and put the proceeds into layered bank deposits?
A: Sorry you feel that way. But yes, my advice was wise.
Firstly, you’re judging the performance of a fund over just five years. You really need 10 years, and ideally longer. Still, we would normally expect a conservative fund’s performance to be okay over five years.
Balances in conservative funds rarely fall much. But they’ve had an unusually rough run since 2020 because of the extraordinary plunge and then rise of interest rates.
This particularly affected the value of bonds, as I’ve explained before. And your fund (you told me the provider) holds about 65% bonds, plus 17% shares, 15% cash and 2% property, according to Smart Investor on sorted.org.nz.
Note, though, that the volatile interest rates also affected term deposits. While your five-year return was below inflation, the same would have happened in term deposits (TDs) – only worse.
TD interest rates tend to look good because they are quoted before tax, whereas fund returns are after tax. Using the Reserve Bank’s average TD rates, and a tax rate of 30%, the return over five years from 2020 on one-year TDs is 12.7%. On three-year TDs, it’s 12.5%. Both are considerably lower than your fund’s 15.25%.
Interest rates and inflation have settled lately. There are no guarantees about the future – especially these days – but most of the time your fund should keep pace with inflation if it stays under control.
If you want to be more certain of beating inflation over the longer term, your best bet is a higher-risk fund, but that’s clearly not suitable for you.
Q: With the Depositor Compensation Scheme starting on July 1, I thought there would have been more talk about it.
I see that finance companies can opt in, providing they meet criteria. Whilst the bank one-year term deposits are returning about 4.25%, I’m sure finance companies could offer 5 or 6%. And providing they are in the scheme, why wouldn’t you invest in the safe higher return? Surely they won’t magically drop to what the banks offer?
A: I expect many people will still prefer bank TDs, perhaps because of convenience or a feeling of security. After all, if a finance company defaults, no doubt there will still be some hassle for investors, even if you get back your money, up to $100,000. So I expect finance companies will still pay somewhat higher interest. It will be interesting to watch.
Q: Just a thought about the “you’re a long time dead” comment last week, when a reader was encouraging a couple to spend more of their savings. My canny Scottish family used to say, “There’s no pockets in a shroud”.
We had few treats by today’s standards, but this was quoted when chocolate ice cream was bought on Sundays.
A: I love it!
Q: Have you looked at Lifetime Equity Release and compared it with reverse mortgages?
A: Yes I have, and it’s an option worth considering.
Lifetime is currently the only NZ company offering what is sometimes called home reversion. The idea is that people over 70 sell a portion of their home to Lifetime, in exchange for a regular tax-free fortnightly income. You don’t end up with debt, as you do with a reverse mortgage. But you do end up owning less of your home.
The home must be mortgage-free, and it must be your primary residence, not a bach or rental. You have to maintain the home, pay rates and be fully insured – which most people would do anyway.
It works like this: over 10 years, you gradually sell to Lifetime Home 35% of your home – at 3.5% a year. In return, each year Lifetime pays you 2.5% of the starting value of your home, minus fees and charges.
Let’s say your home is worth $1 million. Over the 10 years, you’ll receive $22,700 a year (2.5% minus fees) for 10 years – a total of $227,000.
Note that whenever you sell, Lifetime gets its percentage of the property value at that time. After several years, that will almost certainly be higher than the starting value. So the numbers seem pretty uneven – you give 35% of a probably higher value but get only 25% (minus fees) of a probably lower value. However, you receive the money earlier than you pay Lifetime. And money now is worth more than money later!
Before you start Lifetime Home, you have to get advice from a lawyer and preferably a financial adviser.
For a comparison with a reverse mortgage, read on.
Q: My father-in-law is 72 and lives alone after his wife passed away. The pension is his only income and he has about $15,000 in a cash fund. He has a mortgage-free home and lives comfortably on the pension for everyday expenses, but with no cash to spare.
As he gets older he worries about depleting his savings and has been delaying some important home maintenance. We have been talking to him about reverse mortgages and rates postponement (his council offers it to over 65s).
He doesn’t feel comfortable going into debt, so we were wondering about home reversion, eg, Lifetime’s scheme, because of the certainty it offers. It’s not a debt with changing interest rates. Do you have thoughts on the suitability of these newer equity release products versus the various debt options for retirees?
A: You’re right that with Lifetime’s home reversion scheme you don’t go into debt. But there are other pluses and minuses when compared with a reverse mortgage.
Advantages of Lifetime’s Home Reversion:
Advantages of a reverse mortgage – currently offered by Heartland Bank or SBS Bank:
Looking at the numbers, with some assumptions one option looks better financially, with other assumptions the other wins. The assumptions include interest rates, property gains, and the amount and pattern of borrowing in a reverse mortgage.
There’s a tendency for a reverse mortgage to work better for shorter periods – up to about 10 years – and home reversion to work better over longer periods. Heartland says its average term is 6.33 years, but most people won’t know their term when they start.
So – there’s no clear winner. Psychology might well play a part in your decision.
By the way, payments received under both types of schemes are tax-free. Next week we’ll look at some good sources of info on these two types of home equity release.
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* Mary Holm, ONZM, 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 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 or click here. 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.
Term deposit rates have fallen from 6% last year to about 4.3% now.