Putting fun into the finance theory

By MARY HOLM

Q: Could you please give me some information about Bonus Bonds. Are they a good form of investment? How much equity should an investor have in this area?

My understanding is they do not earn interest or charge fees, but give investors the opportunity to crack the major prize each month. A form of Lotto!

A: Bonus Bonds are odd creatures.

If you analyse them - in finance textbook terms - they're not all that impressive. But finance textbooks don't typically make an allowance for fun.

As you say, Bonus Bond holders are paid no interest. Instead, they get the chance to win not only a major prize but lots of smaller prizes.

Every month, one person gets $300,000, one gets $100,000 and one gets $50,000. Beyond that, several get $5000, several more get $1000 and so on, down to lots of people getting $20.

The number of lesser prizes varies according to how much the fund has earned, after tax and expenses, which include 1.33 per cent in ongoing management fees.

ANZ, which runs Bonus Bonds, says there's about a one-in-9600 chance that any $1 Bonus Bond will win a prize each month.

The more bonds you hold (strictly speaking, they're units in New Zealand's largest unit trust), the bigger your chance of winning a prize. And each bond is in the draw every month, no matter how long you've owned it. Some are nearly 30 years old. The Government started Bonus Bonds in 1970.

For the average investor, the prizes currently bring a return of about 4 per cent - although that may drop a little in the next year or so.

Prizes aren't taxed. So the return is equivalent to about 5 or 6 per cent - depending on your tax bracket - on a taxable investment.

That's pretty good these days for an investment that you can get out of more or less whenever you want to. (Theoretically, withdrawals can take up to 28 working days, but it's usually six days or less. Or you can get your money immediately if you pay a $50 fee. There are no entry or exit fees.)

But we're talking about an average return. While many people will do better, and a few will do much better, a great many will make no return at all in any given month.

If you hold lots of Bonus Bonds over a long period, chances are quite high that you'll win something at some time. But, if you're unlucky, it might not amount to much for the whole period.

This doesn't matter as much as it did a decade ago, when inflation was roaring away. But it's still quite possible that your Bonus Bonds won't grow as fast as even the current low inflation.

Normally, in financial markets, the uncertainty of an investment return is regarded as a negative. Investors don't know where they stand. They're taking more risk, so they expect a higher average return, over time, to compensate.

Returns on term deposits are certain. On shares and property they are uncertain - so, over the years, they tend to be higher.

Where do Bonus Bonds fit into this? Unlike shares and property, there's very little chance you'll come out of the investment with less than you put in.

(Your money is invested in Government and local authority securities, corporate bonds and short-term bank investments - pretty safe stuff.)

And there's the chance you'll do enormously well. Your $1 could turn into $300,001 in a month. No share or property has ever done that.

But there's probably less of a chance that you'll do quite nicely, thank you, in Bonus Bonds than in shares or property.

All in all, given the uncertainty of your return, a financial analyst might well argue that you should be getting a bigger average return than you do.

The trouble with that analysis is that it treats uncertainty as something investors don't like. But buyers of Bonus Bonds presumably do like the gambling element of their investment.

It's no secret that New Zealanders love Lotto, the horses, the football club raffle. And many people obviously see Bonus Bonds as a way to combine saving with having a little flutter.

There's nothing wrong with that, as long as you realise that you pay a price for it.

How much? Well, if you have $5000 in Bonus Bonds for five years, these days you're missing out on around $300 a year in interest, before tax, that you could have earned on a term deposit. In a share or property fund, you could probably do better still.

Then again, you've got 5000 chances each month, for 60 months, of winning something.

Or let's say you've got a lot of money for a short period - say $100,000 for a couple of months while you're selling and buying houses.

You might earn $750 interest on that, before tax, in a term deposit.

In Bonus Bonds, with that kind of money, there's a big chance you'll win something. More or less than in the term deposit? Who knows. (Watch your timing on short-term Bonus Bond investments, to make sure you're eligible for as many monthly draws as possible.)

If either of these approaches - investing a large amount for a short time or a smaller amount for a long time - would add a little light to your life, go for it.

I wouldn't, though, tie up a lot of money for a long time in Bonus Bonds.

Q: I recently received my WiNZ distribution statement for the year ended March 31.

The net distribution (after withholding payment credit and withholding tax) was largely absorbed by the management fee.

A footnote states that the management fee may be deductible for tax purposes.

Could you please explain in what circumstances the fee may be claimed and give the relevant section of the IR5 tax return.

Is the tax treatment the same for all unit trusts?

A: Not another question about WiNZ (AMP's index fund holding international shares)! But, seeing it's tax season, we'll do just one more.

Yes, the tax treatment of management fees is the same for all unit trusts.

But you might not be too excited about it. People who pay tax on the gains they make from shares - which generally means frequent traders - can deduct management fees, says Inland Revenue.

Everybody else, says the IRD, can deduct only the portion of the fee that management can attribute to monitoring.

The trouble is most funds, including WiNZ, don't break down their fee into monitoring and other components.

Many funds argue that the full management fee should be deductible by all investors. It's one of those issues that could easily wind up being tested in court.

In the meantime, if you're not a trader, you can either play it safe and not deduct the fee or deduct it and - if you're audited - pay a penalty or perhaps get involved in a test case.

If you want to take the deduction, and you're filing an IR5 tax return, see page 14 of the 1999 income tax return guide.

In Question 16, Return preparation and expenses, include the amount under "Commission on interest or dividend income."

If you're filing an IR3, look for the same wording on page 36 of the guide, Question 25, Expenses.

Q: Please explain why AMP Ltd is not included in the NZSE10 index. The New Zealand portion of this large corporation and the value of the NZ shares held would, seemingly, easily qualify for this.

A: AMP is big enough to be in the NZSE10 - an index of the biggest 10 listed companies. But it's not Kiwi enough.

The stock exchange, which compiles the index, says "overseas shares traded on the NZSE are not eligible".

AMP is, however, allowed into the NZSE40, which - probably partly for historical reasons - has different rules. In that index, it has been ranking fifth lately.

In compiling the NZSE40, the stock exchange counts only AMP shares registered with New Zealand shareholders. If it included the value of all AMP shares, that company would outrank Telecom at the top.

\EE Got a question about money? Send it to Money Matters, Business Herald, PO Box 32, Auckland; fax: (09) 480-2054; or e-mail: maryh@journalist.com. Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number in case we need more information. We cannot answer all questions or enter into direct correspondence with readers.

Bonus Bonds may be sneered at by high-flying analysts, but how many share or property investments give you the chance to scoop a $300,000 windfall?