Mary Holm 's Opinion

Mary Holm is a personal finance columnist for the NZ Herald.

Mary Holm: Borrowing can make a big difference

7 comments
It is a safe bet that taking out a loan for investments can make a good deal better and a bad one worse

You don't have to pick shares and count on luck. It's really easy to spread your risk by using a diversified share fund. Photo / Russell Smith
You don't have to pick shares and count on luck. It's really easy to spread your risk by using a diversified share fund. Photo / Russell Smith

Q: I cannot agree with your comparison two weeks ago of the 10-year return on $100,000 for shares versus property.

Your average 6.6 per cent annual return, compounded on the $100,000 original investment in, say, residential property uses the incorrect base on which to make the calculation.

If you invest in residential property, the base is the market value of the house, not the original $100,000 equity.

Example: If 10 years ago $100,000 was invested in a $500,000 residential property (that is, you made a 20 per cent deposit) then after 10 years the market value of the house might be $950,000 - giving an equity gain of $450,000 (pre-tax), as against a gain in the value of shares in your example of just $126,000 (pre-tax).

The interest on the $400,000 mortgage raised would be covered by renting the property out.

Adjustments would need to be made for other relatively minor costs of rates and insurance.

It is not unusual for commentators who favour shares over property to fudge the comparisons. The tax benefits are the same in both examples, so there is no emotional perceived benefit to a so-called tax-free capital gain on the property, as clearly the investor in shares is in exactly the same position.

Obviously the property investor would have to invest in the right market (say Auckland), but that's no different from the share investor who needs to invest in the right shares.

Let's face it. Share investing for the average punter is legalised speculative gambling. If you are lucky and had invested in Xero shares, then you are currently on a winner, notwithstanding that the fundamentals of that company (that is, not generating a profit) do not in my opinion justify the current share price. It would not surprise me that the speculative share investor is banking on Xero getting a big enough market revenue share to become a takeover target by a much bigger player. You could put 42 Below and many others in the same speculative game.

It's about time that the property investor stopped becoming the whipping boy for favoured tax treatment and that a greater emphasis be placed on the speculative share market gambler.

A: You're mixing geared and ungeared investments. Gearing is when you borrow to invest. In your example you've geared to buy the house, but then compared it with my example of ungeared share investing.

Let's take a look at how gearing works - in either property or shares - for an investor starting out with $100,000.

Firstly, what happens when the investment gains in value? Your example is a good one for a geared property investment. It could be much the same with shares, with $500,000 also growing to $950,000 over 10 years. Instead of rent covering the mortgage interest, dividends could cover it. The pre-tax gain would be the same $450,000.

As you point out, this gives a much bigger gain than in an ungeared $100,000 investment.

But what happens when the investment loses value? Let's say that after 10 years, the value of the property or shares has fallen 20 per cent:

• Ungeared Umberto's $100,000 drops to $80,000. He's lost $20,000. However, he's received after-tax rent or dividends of $4000 a year, which he's invested at 3 per cent after tax. That account has grown to about $47,000, so he has a net gain of $27,000.

• Geared Gerhard has put his $100,000 into an investment like your example, borrowing $400,000 to make a total investment of $500,000. The 20 per cent drop brings the value to $400,000 when he has to sell.

Over 10 years, Gerhard's mortgage has reduced to $330,000, so he pays that off and is left with $70,000 instead of his initial $100,000. He's lost $30,000. And he can't offset that with rent or dividend income, because that all went into mortgage payments.

Gerhard is much worse off than Umberto. In short, gearing makes a good investment better and a bad investment worse.

By now you're probably saying something like, "Yes, but most people borrow to invest in property, but not in shares". That's why I said last week that it's hard to compare typical property and share investments. Nonetheless you can gear shares - as pointed out in the lead Q&A two weeks ago. And many people have ungeared property investments after they've paid off a mortgage.

The only straightforward way to compare property and shares is to gear both or neither.

On taxes, I agree with you. I've often argued that the tax benefits are the same for share and property investments. If Labour wins the next election and introduces a capital gains tax, it will apply equally to property and shares, as it should.

You and I part ways, though, on your comments about investing in the right property market and choosing the right shares.

I agree that making a major investment in a share like Xero is highly risky. But you don't have to pick shares and count on luck. It's really easy to spread your risk by using a diversified share fund - something you can't do with property unless you use a property fund, and that doesn't seem to be what you have in mind.

And I wouldn't call investing in a share fund - something many people do through KiwiSaver - "legalised speculative gambling". It could well be less risky than, say, the Auckland property market, which you seem to be recommending. The very fact that the Auckland market has risen quite fast means it might also fall quite fast.

People often justify Auckland price rises by saying the demand for houses exceeds the supply. That seems to be true. But in any market conditions there's still such a thing as too high a price.

Everyone would agree that an average current Auckland house price of $10 million would be too high. So how can we be certain that the actual average, of around $670,000, isn't also "too high" - meaning that it will fall? I'm not predicting that. I don't know. But there are no guarantees it won't happen.


Be out there

Q: This might help the couple who went bankrupt.

I work in the retail industry. The pay is just above minimum wage. About four of us work to top up our "retirement" income, or get out and have company, as we're over 65 but live on our own, or for other reasons.

The thing is half of the staff come from backgrounds where they earned "serious" money, but when you're over about 50 the opportunities are no longer there, or we want to work locally, or just want something to do, without all the stress.

I met a man at our local supermarket, where he was packing shelves. He stood out as older, well dressed, well spoken, etc. On talking to him he said he lost his job after many years in a well paid job. When I saw him again six months later he said he had been offered a job as a manager at another local shop - all because he was out there - seen by people and talking to people.

Any money is better than none. Not everyone gets $20 an hour or more.

A: Thanks for making some good points. We've still got more replies for the couple, to be published in the next few weeks.


Assessing risk

Q: I am a 40-mumble-year-old woman, moderately well paid in part-time work (around family commitments) and I am not a risk taker, as per the common stereotype of women with respect to their KiwiSaver investments.

I am interested in reviewing the types of KiwiSaver funds (balanced, moderate, growth, etc). With higher income is there not higher risk?

I understand that risk cannot be estimated, so how do I assess the risk associated with each fund? Surely a person's choices reflect their comfort gambling. ("Do you feel lucky punk?", as Clint would say).

From what I see there is no scientific, economic or semi-intelligent method of predicting risk and therefore for informing the choice of KiwiSaver allocations. I have yet to hear an adviser/economist give useful information to assist the decision-making of an average punk like me.

Does it really just come down to my gender and personality type as to what my KiwiSaver income will be? I really would like to be better informed - please help!

A: Your gender has nothing to do with the best type of KiwiSaver fund for you. As you note, women tend to take fewer investment risks than men, but that doesn't necessarily mean that's the right thing to do.

The new KiwiSaver Fund Finder on sorted.org.nz helps you work out your type of fund. A short questionnaire asks about your tolerance for market ups and downs and also another key factor - how soon you expect to spend your savings.

If you plan to spend the money in the next few years - for a first home or in retirement - you probably don't want to be heavily into the share or property market. These are riskier investments and, as you say, they tend to bring in higher average income over time. But you'd be unhappy if, at withdrawal time, the markets happened to be down.

The questionnaire takes this into account, and suggests whether you should be in a defensive, conservative, balanced, growth or aggressive fund. A defensive fund invests in no shares or property - or so little it doesn't matter - with practically all the money in cash and/or bonds. It's the least volatile. At the other extreme, an aggressive fund invests largely or completely in shares and property and is the most volatile.

Note the Fund Finder's warning, that if you have significant non-KiwiSaver savings you should consider that when deciding how much risk to take in KiwiSaver.

Once you've decided which type of fund suits you best, the Fund Finder compares the different KiwiSaver funds within that type. You can rank them according to fees, the number of services they offer, or past returns.


Those fluctuations?

Q: My husband is six years away from retirement and I am 10 years away.

Recently, we switched our KiwiSaver settings from balanced to growth, but was this wise? Perhaps we are too close, relatively speaking, to 65 for the fluctuations that may occur in growth funds.

A: Your age at retirement is not really relevant. What matters is when you expect to spend the money. You might be planning to blow it on travel the month you retire, or use it to supplement your income in your 80s.

As stated above, the KiwiSaver Fund Finder allows for this. If you're planning to spend the money:

• Within three years, it will recommend only a low-risk defensive or conservative fund - even if you're a risk taker.

• Within four to nine years, it will recommend a defensive, conservative or balanced fund, depending on your attitude to risk.

• In 10 years or more, it will recommend any of the five types of fund.

Have a think about your plans and try the Fund Finder. Perhaps at least your husband should switch back to a balanced fund. While you're at it, you can both see whether you're with the best provider for you.


Mary Holm is a freelance journalist, part-time university lecturer, member of the Financial Markets Authority board, director of the Banking Ombudsman Scheme, seminar presenter and bestselling author on personal finance. 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.

- NZ Herald

Send questions to mary@maryholm.com or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We won't publish your name. Please provide a (pref daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice.

Mary Holm

Mary Holm is a personal finance columnist for the NZ Herald.

Mary Holm is a columnist, best-selling author and seminar presenter on personal finance. She is also a director of the Financial Markets Authority and the Banking Ombudsman Scheme, and holds an MBA in finance. Previously she was business editor of the Auckland Sun and Auckland Star, and has worked for the NZ Listener, Australian Financial Review and Chicago Tribune. She has been called “The nation’s favourite investment agony aunt.”

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