Hang on tight, despite the drops

By MARY HOLM

Q: Two years ago I received a substantial redundancy payout.

I was able to find another job so my wife, who also works, and I decided to pay off the mortgage and dollar cost average (drip feed) the remainder over 18 months into a world share index fund, to be used for our retirement.

We have just finished investing the money and are now sitting on about a 20 per cent loss.

We are prepared to wait the six years until retirement for prices to recover, but wonder what the chances are of that recovery.

Common wisdom, based on US market data, says there has been no 10-year period when funds show a loss. But does this apply to NZ dollar-denominated index funds?

Does the "10-year rule" mean nominal loss, or does it mean no loss in real, inflation-adjusted, terms?

Even if the fund recovers in the next six years, we will have earned nothing for eight years and lost value to inflation.

With US markets heading for an unprecedented third straight down year, perhaps we should sell, take our losses and put the money in the bank where the chances of a real return seem better.

What would you suggest?

Winston Churchill, so I'm told, once made a seven-word speech at a high school break-up.

"Never give up", he said. "Never, never give up."

That's not always true in investment. But you two - great examples of model investors who have struck extraordinarily bad luck - should heed his words.

You did everything right. Firstly, you got rid of your mortgage.

Secondly, you put the rest of the money into a world index fund, which is an excellent long-term investment. And eight years is long-term by most people's standards.

Thirdly, you used dollar cost averaging, which means you invested equal amounts on a regular basis, in your case over 18 months.

Because world share prices have fallen, the units you bought in recent months were at relatively low prices. If, instead, you had invested the full amount 18 months ago, you would now be sitting on a bigger loss.

Clearly, though, you're not happy with your choice of investment.

As it happened, your timing was terrible. If you had gone in a few years earlier you would be way ahead.

The returns on the MSCI world share index in NZ dollar terms - which will be similar to those on your fund - were 41 per cent in 1997, 37 per cent in 1998 and 27 per cent in 1999.

Then, in 2000, the index rose only 2.6 per cent. And last year it dropped 11 per cent. What next? Nobody knows, but you're wise to look back at 10-year returns for an idea of what might lie ahead.

Looking at the MSCI in Kiwi dollars since 1970, there have been no 10-year periods in which you would have made a loss. Once we adjust for inflation, though, there were losses in the 10-year periods ending in 1979 through 1983, although none since then.

Those losses resulted largely from rampant inflation. CPI increases of between 10 and 16 per cent a year in the mid-1970s chomped into real returns.

Note, though, that shares were by no means the only investment affected. Everything was.

On houses, real returns were negative from the mid-1970s to early 1980s and occasionally since then.

And in the bank - where you're thinking of moving your money - it's a bit of a horror story. Real returns were negative the whole time from the late 1960s to the early 1980s.

If we concentrate on the more recent low-inflation times, real returns on all investments have been better - including world shares.

In all the 10-year periods ending 1990 through 2001, real returns on the MSCI in Kiwi dollars have ranged from 4 per cent a year to 14 per cent.

It would seem, then, you're being too negative when you say that even if your fund recovers in the next six years you will have earned nothing and lost value to inflation.

You're assuming your investment will merely grow back to where it was when you put the money in.

But history suggests it will probably do considerably better than that.

I also think you're too negative about prospects for the US share market this year.

Another important point: It could be argued that we should have looked at six-year returns, as you have six years until retirement. In fact, though, your time horizon should probably be more than 10 years.

It's not a good idea to get out of all share or share fund investments on the day you retire.

You're quite likely to live another decade or two. And over 10 or more years your money is highly likely to grow more in shares than elsewhere.

On retirement, while you should move money you'll need over the next few years into a fixed-interest investment, the rest could stay in the share fund for quite a few more years.

I'm predicting that, by retirement day, you'll be happy enough to do that.


* Mary Holm is a freelance journalist and author of Investing Made Simple. Send questions for her to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@pl.net. Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice outside the column.