Stay calm in the rough

By MARY HOLM

I am 61 and earning $38,300 a year. My husband is 63 and unemployed. We own a mortgage-free home.

My brother, who has been retired for seven years, told us he lives comfortably with a $12,000-a-year top-up on the Super.

Therefore, our aim has been to have $240,000 by the time I retire in three and a half years. We have $60,000 in term deposits, $12,000 in Bonus Bonds, $21,000 with MFL Property Fund and $125,000 in ASB Easyplan Balanced Fund.

We thought we were getting comfortably close to our target until September 11 caused $7000 to "disappear" from our Easyplan investment.

Do you think we should "ride out" this and leave our investments as they are, or move some away from the Easyplan scheme. If so, to what?

Stay on your bicycles.

As you're learning, any investment that includes shares can be a bumpy ride. But people who hang on through the rough stuff tend to do well long term.

I've received many letters like yours in the last few months. And in some cases the losses have been quite a lot bigger than your $7000 on $125,000.

That's partly because your fund invests only about 54 per cent of its money in shares, with most of the rest in fixed-interest investments. That modifies the ups and downs.

Investments in pure share funds have fallen further.

On the other hand, the more heavily you're into shares, the more growth you're likely to get over the long run. But that growth comes in fits and starts.

A glance at the little graphs of different sharemarkets, which run with the Business Herald's share tables, shows most markets have been pretty healthy over the past month or two. (This suggests, by the way, that September 11 didn't cause the slump. It was under way well before that.) For all we know, shares might already be making a comeback. Then again, further downturns may come in the months to come.

But in the long term the trend is highly likely to be upwards.

Are the three years or so until your retirement a long enough term?

Many would say, 'No', if you were in a pure share fund. There's about a 15 per cent chance an investment in shares will lose value over three years.

In a balanced fund that is much less likely. And there's no reason you should get out of the balanced fund on retirement day.

I would keep at least some of your savings in the fund well into retirement, simply because it has good long-term growth potential.

Having said this, I note that you signed yourself "Careful Investor".

If you're really finding it hard to cope with the fluctuations in your balanced fund, perhaps you should move some or all of the money to Easyplan's conservative fund.

That has about 27 per cent in shares and most of the rest in fixed interest. It will fluctuate less, but probably also grow more slowly over the years.

ASB says there would be no charge for you to move the Easyplan fund.

We invest more than $1000 a month in several managed funds, with strong leanings towards international shares.

Obviously these funds have taken a bit of a "hit" in recent times, but as contractors we're fairly used to swings and roundabouts.

However, a recent three-monthly statement showed big drops in our investments in Tower Tortis International and, to a lesser extent, the BNZ Active Growth Fund.

We have no intention of selling, but is it really worthwhile continuing regular monthly contributions into these funds at present?

Would it not be more sensible to cease further investments and put the money in a bank deposit account?

You're one step ahead of the previous writer, in that you're not planning to bail out. Good on you.

But you are balking at putting more money into what look like iffy investments. That's understandable.

As the saying goes, "Don't put good money after bad".

But I don't think the two funds are bad.

It's just that Tortis International is pretty much fully invested in shares and the BNZ fund about 60 per cent in shares. Lately, that's been bad news.

Still, there are two good reasons to keep depositing into them:

* The units are cheap.

While we're all happy to buy cheap strawberries, many of us aren't so keen on cheap shares.

I suppose that's because we eat the berries. But with shares, we worry about their ongoing value.

I certainly can't guarantee share values won't fall further.

But prices are certainly well down on 18 months ago. And I would be surprised if in 10 years this month's unit prices don't look pretty low.

One big advantage of investing a fixed amount regularly into shares or share funds is that you buy more shares or units when prices are low.

With lots of cheap units and fewer expensive ones, the average price you pay turns out to be lower than the market's average price.

This is called dollar cost averaging. Over the years, it can save you lots.

But it will work only if you keep investing when the markets are down.

* If you stop contributing when times look bad, planning to get back in when things improve, you're doing what's called "timing the markets".

It's would be great if you could do it. But, as Bernard Baruch said: "Don't try to buy at the bottom and sell at the top. This can't be done - except by liars."

Nobody knows when we're at a top or a bottom, until later. And many people have lost lots because they thought they knew.

A study shows that if you invested in America's S&P500 (biggest 500 companies) for 10 years up to March this tear, you would have made 12.9 per cent a year. But if you happened to be out of the market - perhaps waiting for the next boom - for just the 10 best trading days in that decade, your return would drop to 8.9 per cent.

If you missed the 30 best days, out of more than 2500 days, your return would be only 4.1 per cent.

Okay, nobody is going to be unlucky enough to miss out on all the best days. But share booms can happen pretty suddenly. It's easy for market timers to miss some great trading days.

Thanks for your consistently outstanding and articulate treatment of equity investing basics.

I am particularly impressed with your recent emphasis on index funds and the very compelling path to long-term growth that they offer.

I think it's worth clarifying for your readers a few key points about the impact of dividends within equity index funds like the Tower funds.

Dividends paid to common shareholders do not represent growth!

When a company pays its common shareholders a dividend, cash is taken out of the company and the share price drops by the amount of the dividend, to reflect this.

No value or growth is created. It just changes form, from share price to cash in hand (or more shares, if reinvested) for no net gain.

But if the dividend is not reinvested, capital erosion occurs.

In summary, in a share fund like the Tower Tortis International Fund, growth does not come from dividends, but from price appreciation.

This point is important because many shareholders naively and erroneously believe that dividends are some kind of free handout, and that dividends from common shares represent growth. They don't.

It's about time I made this point again, so thanks for doing it for me.

People do think dividends are more significant than they really are.

In a famous academic paper, Americans Merton Miller and Franco Modigliani concluded that dividends don't matter.

If a company pays out more in dividends, they said, it retains less of its profits for growth. That means the share price will grow more slowly.

The shareholder gets more in cash, but less in share appreciation.

The reverse happens if a company reduces its dividends. Other things being equal, the company will grow faster, and so will its share price.

If shareholders want more income after a dividend cut, they can sell some of their shares, which will be worth more because of the higher growth.

M and M - as the academics were called long before a certain rap singer and probably the little coloured lollies - acknowledged that taxes and so on can affect dividend policy. But broadly speaking, what they say is true.

And we need to bear it in mind when comparing dividends on New Zealand shares and overseas ones.

Australian companies tend to pay lower dividends than here. And in international share funds, the dividend yield is often so low that fees cancel it out.

But international share prices - and hence, unit prices in international share funds - tend to grow faster over the long term than do NZ prices.

All of this is not to deny what academics call the "signal effect" of a change in dividend policy.

It's true that, if a company cuts its dividends and retains more profits, investors are not harmed.

But it's also true that companies that cut their dividends may be doing so because their profits are smaller.

Companies that boost dividends may be experiencing good times.

A change in dividend policy, then, may be a signal to the market of a company's changing fortunes.

It's not always clear cut, though. If a company suddenly sees new growth opportunities, it may cut dividends and keep more profits to finance that growth. Its prospects might be great.

It's important to listen to what the company is saying, and put the dividend change in context.

Regardless of dividend levels, I agree with your point about reinvesting dividends. You can't necessarily expect a share portfolio or share fund to grow if you don't reinvest.

A final point: Everything you and I have said applies to all shares and all share funds, not just index funds.

* Mary Holm is a freelance journalist. Send questions 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.