How to get us all investing more

By MARY HOLM

Q: I want to put to you my idea on how to get individuals investing more.

It is this: Split income derived from paid employment from that derived from investing activities.

Tax the two separate streams in just the same way that income is taxed now. That is, suppose an individual has a work-related income of $50,000 and income from interest, dividends, rents or leases of $30,000.

The two are split, and the $50,000 attracts tax at the usual marginal rates just as it does now. But the $30,000 is not taxed at the top marginal rate. The first $20,000 attracts only 20c in the dollar etc.

This scheme provides an incentive for small investors, and the large investors will pay the full marginal rate on their considerable investment income.

Would this not encourage savings?

A: Your idea has some merit. But I'm not rushing to endorse it. Firstly, would it be fair that someone who has both work and investment income pays a lot less tax than someone with a similar total income but all earned from the sweat of her or his brow?

Secondly, many people, especially the self-employed, would find all sorts of ways to convert work-related income into investment income.

Most importantly, I'm not sure any kind of tax incentive for saving is right for New Zealand. Here's why:

* A tax incentive would deprive the Government of millions of dollars in revenue.

Could that be justified? Yes, if many people who would otherwise not have saved do so, and if many savers save more. But research suggests that those who would take most advantage of the incentive would be those who would have saved that money anyway.

The result could be a much poorer Government - and hence a lower level of Government services, such as health and education - for little additional saving.

"OK," you might be saying, "but other countries seem to think tax incentives are worthwhile."

The difference, as Retirement Commissioner Colin Blair recently pointed out in a submission to the Tax Review 2001 Committee, is that in many other countries state pensions are income tested.

If people there save more because of incentives, their income will be higher and so their state pension will be lower.

But in New Zealand, where everyone over 65 gets NZ Super regardless of their financial situation, there would be no such Government saving.

* Simply because NZ Super is more generous than in most other countries, there is less need for tax incentives.

* In any system of tax incentives, the Government must define which savings or investments qualify.

Inevitably, some activities will miss out. It can easily be argued, for instance, that spending money on tertiary education is a form of investment, because it will probably lead to higher income later; similarly, spending money on setting up a business. But the Government is unlikely to give a tax incentive for those types of investments.

If it did, all sorts of abuses would arise. It's amazing what could be defined as an education or business set-up expense.

If it didn't, some people who otherwise would have spent money in those areas would, instead, invest where they could take advantage of the tax break. And less spending on education and entrepreneurship equals less economic growth.

Individual savings are undoubtedly good for the individuals and the country.

But I would rather see our savings grow because our economy is strong than because we've been given a tax break.

Q: It concerns me greatly that someone in your position, with the huge audience that you enjoy through the New Zealand Herald, sees fit to make comments about "efficient sharemarkets" when you obviously do not understand the cause and effects that take place in world sharemarkets and in particular, in New Zealand's market.

If markets are as efficient as you suggest, I would be very interested to hear your reasoning for some of the falls experienced in the US markets in the last weeks.

If markets were as efficient as you say, stocks such as Nokia and Oracle would not have fallen up to 25 per cent in less than two weeks. Falls or gains of this magnitude are not based on an efficient market or any relevant information as you suggest, but on the emotions of institutions and investors.

I would suggest that someone with the background and knowledge of Warren Buffett would have a better understanding of market behaviour than many so-called financial advisers.

Mr Buffett says: "The continuous 63-year-old arbitrage experience of Graham-Newman, Buffett Partnership, and Berkshire illustrates just how foolish the efficient market theory (EMT) is."

He says EMT discussion became highly fashionable in academic circles during the 70s and, as you said, assumed that markets are/were efficient.

He clearly demonstrates this to be incorrect thinking by "gullible investment professionals" who have swallowed EMT.

I suggest you read some of his work and gain a better understanding of business and EMT through someone with a vast amount of experience, ability and knowledge.


A: I have read some of Buffett's writing. I particularly like his emphasis on buying and holding shares, rather than frequently trading.

But, while I join most others in admiring his investment success, he hasn't yet persuaded me to drop market efficiency.

When I got your letter, I e-mailed a copy to David Emanuel, Auckland University accounting professor and a director at the Big Five accounting firm of Andersen, who says he remembers teaching a bright student by your name years ago. Was it you?

I had planned to discuss what you said with Emanuel. Instead, he sent me a written response.

"The efficient market hypothesis simply states that prices react rapidly and in an unbiased manner (that is, not obviously by too much or too little) when new information becomes available," says Emanuel.

"This description is based, at least in part, on the fact that share markets are inhabited by many skilled individuals (and of course some not so skilled), who both buy and sell, and who cannot as a general rule manipulate the price.

"Further, given a reasonably free flow of capital across countries, international share, bond, bill, derivative and currency markets are interrelated. So prices in one market are related, indirectly, to prices in another.

"Given this description, efficient market advocates expect that investors in the aggregate do a pretty good job in pricing securities efficiently, in much the same way as punters at the racetrack (particularly where bookmakers exist) do a pretty reasonable job in setting the odds on horses before the race is run.

"Some punters barely know one end of a horse from the other, but that does not make the starting price odds wrong. We will only know that after the race has been run.

"Of course, not everyone subscribes to this view, and even those who think markets in this sense are efficient use it only as a reasonable working approximation, and will readily admit that there are anomalies.

"Those who are most opposed to the efficient market hypothesis believe they can pick mispriced securities by buying those that are under-priced and selling the over-priced securities short.

"It turns out that this is easier said than done. Although Warren Buffett has been an outstandingly successful investor, all others have fallen short of his performance, and many stock-pickers have done about average.

"That means that before including transaction costs they have done about as well as an index fund, which is what you would expect in an efficient market.

"The rise and rise of index funds is an acknowledgement of market efficiency.

"The fact that occasionally one observes large share price movements, like those of Oracle and Nokia, is not inconsistent with an efficient market.

"From time to time this is to be expected, particularly among shares where there is a high degree of uncertainty.

"While one can undoubtedly learn much from the books by or about Warren Buffett, it's a bit like learning about basketball from Michael Jordan.

"They are the best, and reading about what they do may help. But whether the rest of us can emulate their success is much less clear.

"Further, the fact that an exception or anomaly is found does not destroy the theory, in the same way that finding that an individual reacts poorly to penicillin does not negate the hypothesis on which the use of penicillin is based.

"So the question is: Which general description of share markets is likely to be the more helpful - one that embraces the idea that the multitude of analysts, who try and make a reasonable living by assessing the value of securities on an hour-by-hour basis, are good at what they do, or one based on irrationality, sentiment, and emotion?

"Obviously neither specification is going to be entirely adequate.

"But starting from an efficient markets perspective is likely to get you a lot further, in terms of description and understanding, than starting from anywhere else."

Convinced? I am.

Q: I am in receipt of a company annuity, the result of 40 years service with a former employer, and basically have no regrets with the tax-free stipend.

I follow your column, and recently there have been comments on annuities generally, but particularly where a reader suggested annuities could lose certain advantages due to "future government policy shift".

I guess it's always possible. But I believe I'm correct in suggesting that a few years ago when the surcharge was in full force, only 50 per cent of any annuity was taken into account in assessing one's eligibility for any state pensions.

This indicates that annuities would not be treated savagely in any future legislation.

Even if by some mischance they were badly treated, I believe the insurance company would probably have to adjust the annuity payments to restore parity of earning power.


A: You're right about the surcharge. When it was in effect, only half the income from an annuity was included in the retired person's total income for surcharge purposes.

In much the same way, only half of annuity income is included when the Government is assessing whether someone is eligible for a rest home subsidy.

This is only fair, if you compare someone who buys an annuity to someone who puts a lump sum of the same size into a bank account.

The annuity payments will be bigger than the bank interest payments. That's because part of each annuity payment is like a return of your capital. It's the equivalent of the bank account holder taking out not only interest but also part of their principal each month.

If the account holder did that, the Government wouldn't include those principal withdrawals as income. So half of annuity payments aren't included as income either.

Can we conclude from this that annuities wouldn't be treated savagely in future?

We can't be sure, of course, but it does indicate that the Government is fair about these things.

The number of people who receive annuities - or private pensions, which are the same thing - will rise as Baby Boomers retire, so it's hard to imagine a government legislating unfairly against them.

It's not true, though, that insurance companies would have to adjust annuity payments if the rules changed so that recipients wouldn't suffer.

A typical annuity document says the company may change its payments if the tax system changes.

That's a risk, admittedly. Keep in mind, though, that annuities eliminate some other major risks - that you'll outlive your money and that returns on investments will fall.

All in all, I think they are a good idea for many people.

Speaking of taxes, you refer to your annuity as tax-free. Strictly speaking, that's not correct. The insurance company has already paid tax on the money before it sends it to you. So you don't have to pay any further tax.

* 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.