Mary Holm: Yes investors, there really is a free lunch

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OPINION:

Q: I have got shares for Mighty River and Meridian. I got them on IPO years ago. And they both are doing very well, from an initial $6000 to now $38,000.

I understand the importance of diversification, but I do not have the skill at picking stocks so I am thinking of selling all the shares while the value is high and using this money to get into a share fund. Is this a good move?

A: Yes. Definitely. Certainly. Without a doubt.

I say that — with much enthusiasm — not because this is a good time to sell. I don't know if it is — and nor does anyone else. But it's always preferable to hold a wide range of shares or invest in a share fund, rather than holding just a few shares. And that's especially true when the shares are in the same industry, as yours are.

Some people will challenge me, based simply on your numbers.

The share prices of your two companies have indeed grown nicely. Mighty River (now called Mercury) has risen nearly 2.5-fold — meaning the price is almost 2.5 times what it was — since the company's initial public offering (IPO) in 2013. And Meridian has risen more than five-fold, says NZX.

If we add reinvested dividends, Mercury has risen close to four-fold and Meridian more than eight-fold.

This compares with the NZX50 gross index, which includes dividends, which has risen 2.7-fold over that period.

So you've had much better growth than the market average by sticking with just two shares. However, you're honest enough to say you don't know how to pick shares — join the club! So your superior performance has been good luck.

Will that luck continue if you stay with the two Ms? It might — and you will wish you had ignored me. But that's a much riskier strategy than moving your money into, say, a low-fee index fund based on the NZX50.

Let's look at some ranges of likely annual returns:

• On a single share, the range might be minus 40 per cent to plus 60 per cent. The average return is plus 10 per cent.

• On two shares in the same industry — such as yours — it might be minus 30 per cent to plus 50 per cent. The range is smaller because a big rise or fall by one share will be offset somewhat by a lesser rise or fall by the other. The average return is still 10 per cent.

• On the 50 shares in the NZX50, the likely range might be minus 10 per cent to plus 30 per cent. The big rises or falls by a few companies are heavily watered down by all the other shares. The average return? Our old friend 10 per cent.

These numbers show what happens when you diversify — spreading your money over lots of investments. You miss out on really big gains, but you also miss out on really big falls.

Most people like that trade-off.

And here's the clincher: your average return is unchanged.

There's a saying in investing that there's no such thing as a free lunch — supposedly first said by 19th century English industrialist and philanthropist John Ruskin (who had an intriguing rambling home in the Lake District that I've visited — but I digress!).

The saying is often used to point out that if you want to reduce risk, you must also reduce your expected return. And if you want a higher return, you must take on more risk. In most cases you can't have one without the other.

But there's one exception. Through diversification you can lessen the risk of making a big loss without sacrificing average return. That's why diversification is sometimes called the only free lunch.

SELF-INSURE YOUR HEALTH

Q: Recently I have read a few articles on health insurance in your column.

Well ... I let my health insurance go when I was 40 and I'm now 70. I made a point of saving the amount I would have used for my policy into a serious saver account. Since I was 40, I've had four operations at a total cost to me of around $20,000, and all in private hospitals.

However, I have calculated I would have paid approximately $200,000 into my health insurance in that time, and what I haven't given the insurance company is in my savings for other use, or in an unforeseen case another operation. I told my doctor this and he said he and his doctor wife didn't have health insurance and did the same.

I realise this doesn't work for everyone, and one needs to be disciplined in saving, but it's worked for me, and I just wanted to share this with others.

A: Self insurance has indeed worked for you — so far at least. And it will work for many people, given that premiums paid have to cover not just the average person's health costs, but also the expenses of running the place — even for not-for-profits like Southern Cross.

Last year, Southern Cross paid out 85c in claims for every dollar received.

However, it won't work for the unlucky people who have major health problems — especially soon after they start their self-insurance plan and have little in their savings account. And as I said in this column recently, the last thing you need when you have health worries is money worries as well.

In last year's most expensive claim, Southern Cross says it paid $166,000 for cancer surgery. Imagine footing that bill yourself — plus other health expenses over the years.

Rather than dropping insurance altogether, if you are reasonably healthy I recommend getting cover for major medical expenses only, and also increasing your excess. See the next Q&A.

By the way:

• I think you might be exaggerating your $200,000 savings — which amounts to $556 a month over the years.

Southern Cross says total premiums on their most expensive plan from ages 40 to 70 would have been $178,000. On its most popular plan, it would have been $110,000. And both numbers are without any discounts, which commonly apply.

More importantly, that's using today's dollars. If we adjusted for that, your savings would have been considerably less.

• At the risk of inviting a deluge of protest letters, I wouldn't take financial advice from a doctor — unless they also have financial expertise — any more than I would take medical advice from a money expert!

• I hope you don't have any long-term, expensive health problems in the future.

SOUTHERN CROSS COSTS

Q: Several elderly readers are struggling to pay their Southern Cross Healthcare premiums. I increased my excess for myself and wife from $1000 to $4000 and reduced the annual premium by $2000.

I think this is preferable to cancelling, as we still have substantial cover for a major health event.

A: Absolutely. The big bad stuff is the worry. And Southern Cross confirms that your numbers are about right.

KEEP GST SIMPLE

Q: Removing GST from specific items (for example health insurance, as suggested by a previous correspondent) is a terrible idea.

The great thing about New Zealand's tax system is that it is incredibly simple, and there are no loopholes. At the moment, we pay GST on everything (and yes, there are a few exceptions such as bank fees), and the reconciliation process is simple. Having lived overseas I have seen the alternative, and you end up with incredibly complex tax returns.

If GST is removed from an item (e.g. fruit and vegetables has also been proposed) then it has the following implications:

• The missing tax must be "made up" from somewhere (raise the remaining GST rate?)
• Lawyers must define the limits of the exemption (surely an apple pie is a fruit?)
• Accountants have to update their business tax return process to reconcile the exemptions
• People who cannot afford professional advice may miss out on the full advantage
• The IRD has to "staff-up" to explicitly monitor the exemption
• Lawyers have to litigate the cases where some Smart Alec comes up with a new financial instrument that exploits an unforeseen loophole
New Zealand has a really simple tax system — let's keep it that way, and use the existing levers (tax bands and rates) to help address inequality.

A: Just reading your list makes me feel exhausted. All that extra work!

You make some excellent points. Perhaps the overriding one is that, yes, our tax system is a lot simpler than many, with a big chunk of the population not having to file tax returns. Long may that last.

CHRISTMAS GIFTS WITH MEANING

Many charities offer Christmas gift programmes. You buy items for people in need that are given on behalf of your family or friends. For example, you might donate money for school equipment in developing countries. You receive an acknowledgement to give to your relative or friend to show what they have "donated".

It makes a great Christmas gift — more meaningful than buying stuff for one another that is often not wanted.

Each year, this column runs a list of charities that take part in these programmes. I've asked each one to describe their programme in 20 words or less:

• Caritas Aotearoa New Zealand: 0800 22 10 22 or https://caritas.org.nz/get-involved/caritas-gifts. "Caritas gifts of hope, life, peace and learning enable our life-changing work around the world and in Aotearoa New Zealand."

• ChildFund New Zealand: 0800 808 822 or www.childfund.org.nz. "Give new ChildFund gift cards this Christmas. Less stress for you, more choice for your loved ones in helping children."

• Christian World Service: 0800 74 73 72 or www.gift.org.nz. "Give someone special a gift that brings joy — school for a child, a garden for a family, a rainwater tank."

• Leprosy Mission New Zealand: 0800 862 873 or www.reallygoodgifts.org.nz. "Give God's abundant blessings to people facing leprosy this Christmas, with access to the cure and contact tracing from $10."

• MEND NZ — Mobility Equipment for Needs of the Disabled: 021 060 9631 or www.mend.org.nz. "Give African or Himalayan youth a limb to walk to school or hearing aid to hear for the first time."

• Oxfam New Zealand: 0800 600 700 or www.oxfam.org.nz/shop. "New products and perfect pairings — choose from Oxfam's range of ethical goods and meaningful unwrapped cards for gifts with purpose."

• Tearfund: 0800 800 777 or www.tearfund.org.nz. "Give a goat ($50), help a survivor of trafficking ($35) or give a Lebanese family a Covid-19 hygiene kit ($35)."

• The Fred Hollows Foundation NZ: 0800 227 229 or https://www.hollows.org.nz /gift-of-sight. "Give the gift of sight to someone in the Pacific by sending our gifts or cards to a loved one."

• The Salvation Army: www.justgifts.org.nz. "Give a gift that tackles poverty and injustice in the Pacific and around the world."

• World Vision New Zealand: 0800 800 776 or www.worldvision.org.nz/smiles. "Add changing a life to your shopping list. From chickens and goats to virus-fighting handwashing stations — World Vision's Smiles gifts."

Keep on giving

A woman at one charity also asked me to add the following: "I read your column and know that you have been covering the issue of cheques being withdrawn by the major banks. This has a significant impact on the charity sector, as people are not forced to find an alternative to donate unlike having to find an alternative to pay a bill.

"Please firstly give a shout out to all the amazing people who support charities with donations by cheque and thank them for their commitment to many good causes over many years.

"Secondly, please ask them to contact their bank or the individual charities to find a way that suits them to continue their commitment, which is so vital in making real changes in the lives of the vulnerable and marginalised."

- 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 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.