Q: When the market is volatile and falling, professional investors sell some riskier assets and increase cash.
Yet small investors typically receive the opposite advice if they suggest moving to cash or conservative funds to wait out the volatility — as in your column in recent weeks.
Why is the advice different for small investors when the financial logic (sell high, buy low) is the same for everyone? Is it concern they'll forget to switch back to riskier assets as markets recover?
They should be given the full story. Leaving them to ride the wave all the way down is just using their money to prop up smarter investors.
A: Gosh! Am I part of a conspiracy to help out professional investors at the expense of readers?
Let's start by assuming — falsely — that it's possible to pick a good time to sell shares, and a good time to buy back in again.
Some fund managers and other professionals say they can do it. Perhaps they called it right and sold shares before the recent market plunge. And they plan to get back into shares just before they rise again.
The markets have, of course, already regained more than half their Covid-19 losses. I wonder if these people got back in before that happened, or whether they're waiting to see if we have another plunge — and have meanwhile missed some healthy gains.
It's tricky stuff, this market timing. As I said last week — which I should note was after you wrote to me — world champion share investor Warren Buffett doesn't try. Do you really think small investors have much chance of getting it right?
Think about what would happen if I were to say to readers, "The market's gone wobbly. Get out as soon as you can and come back in when it settles."
By the time I said that, of course, share prices would already have dropped. And readers are highly likely not to get back into shares until too late. It's not that they will forget, but they'll wait until they've seen at least several days, if not weeks, of steady price rises — and therefore miss those gains.
Here's a key point: for everyone who sells shares at just the right time, there has to be someone who buys those shares at just the wrong time. Ditto for everyone who buys back into the market at just the right time. Someone sold to them and lived to regret it.
And who is more likely to be on the wrong side of those trades — the professional who spends all day watching market developments or the small investor?
History has shown us over and over that ordinary investors are better off sitting on the sidelines. And, by the way, many top professionals do just that too.
Q: In a recent column you commented, "Any time is a fine time to switch [KiwiSaver] provider. If you move to a fund with the same risk, losses are not an issue. If you sell low, you then buy low.
"But if you want to raise or reduce your risk at the same time, I suggest you first move to a same-risk fund, and then gradually change your risk level a bit at a time."
How can you do this "drip feeding" into a new fund? From what I understand, the only current option is to move all your KiwiSaver funds from one fund to another; that is, the option to move a percentage of funds over a period of a few months isn't available.
A: To my knowledge, Simplicity is the only KiwiSaver provider that doesn't let members be in more than one of its funds.
Most providers will also let you contribute to more than one fund, or contribute to one fund while leaving your earlier savings in another one. If you want to do something like that and your provider won't let you, switch to one that will. To switch, just ask the new provider to arrange it.
I don't know of any provider that allows you to set up an automatic gradual transfer of, say, 20 per cent of your money from one fund to another every month. But you can always just contact them monthly.
Apart from gradually changing your risk level, other reasons for being in more than one fund are:
• You want to try a higher-risk fund with a portion of your savings, to see how you cope with the greater volatility, before perhaps moving the whole lot to higher risk.
• In retirement, it's good to have the money you plan to spend in the next few years in lower risk, but the longer-term money in higher risk.
Simplicity explains its policy this way: "True to our brand and our philosophy, we choose to offer only three core funds in KiwiSaver as we didn't want to overcomplicate things for ourselves and our clients. Limiting our investors to one fund type simplifies reporting and registry requirements and keeps costs down for members."
Fair enough. You pay less and get less — which is fine for those who don't need to be in more than one fund.
Slicing the PIE
Q: I have a question that applies to KiwiSaver and PIE funds. I have been meaning to ask this for a while but given what has happened to fund balances lately, I thought I should get on to it.
Say a person invests $1000 in KiwiSaver. The fund goes up to $1200. The investor then pays tax on the $200 increase in the fund.
Covid-19 comes along and the fund value drops to $800. Things recover eventually and the fund value goes back up to $1000. The investor then pays tax on the $200 increase in the fund.
At this point the fund is only equal to the original investment.
Are we potentially continually paying tax over and over on the same increases in fund value? Or have I missed something?
A: You've missed quite a lot actually. The situation is much better than you think.
I suspect many investors in KiwiSaver and other managed funds don't realise how they're taxed, because it's all taken care of by the provider.
All KiwiSaver funds and probably all other managed funds are portfolio investment entities, or PIEs. And the good news is that investments in PIEs are taxed pretty gently.
For a start, PIE tax rates are a bit lower. For example, the top tax rate is 28 per cent, compared with 33 per cent on other income.
Also, basically you pay tax on income earned in the fund — such as interest and dividends — but not on gains in the value of the investments.
However, the dividend situation is a little bit complicated:
• On New Zealand shares, you end up paying little tax on dividends. Under our dividend imputation system, shareholders get credit for the tax the company has already paid on its profits, so there's no further tax on many shares. What's more, investors in lower tax brackets sometimes end up with excess imputation credits, which can then reduce their tax on interest.
• In Australia there's a similar system, called franking, but New Zealanders don't benefit from it. So KiwiSaver members and others pay tax on the full Aussie dividends received.
• On shares from other countries, instead of paying tax on the dividends, there's a special tax of 5 per cent of the value of the shares — regardless of whether the shares have paid dividends or gained or lost value.
Turning to your example, on both occasions when the fund value rises, much of that is probably because of changes in the values of investments, and you're not taxed on that.
However, there will be some interest and dividends as well, and you will be taxed on those as just outlined.
It might be helpful to think of your KiwiSaver account as being like a rental property that you have no plans to sell. Each year you pay tax on the rent minus expenses. Meanwhile, the value of the property goes up, and sometimes down, but that is not taxed.
Q: I fully believe in your advice for passive investment and do that for all my investments. Saying that, in some situations, can we not use technology to earn extra money?
During the past couple of weeks, I managed to buy shares and ETFs at a good price by using "limit buy" orders on Sharesies. I didn't get the lowest price but bought them for a decent price. Some of my limit buy orders were set for really low prices so didn't materialise.
Everything I am buying now is for the long term, but by buying it for a lower price than normal, hopefully my returns will be better. My point is that if you have cash available then there is no harm in using technology to get some bargains.
The market is expected to be volatile for the next six months, so I wanted to get your opinion on using limit buys to get some bargains if people have cash and patience. Thanks.
A: For the benefit of other readers, if you use a limit buy — or buy limit — you put in an order to buy a share, but only if you can get it for $x or less. You can also use a limit sell, specifying a price that you won't go below.
If, instead, you were to use an ordinary market order to buy a share, you might pay a bit more — or potentially a lot more if the share price zoomed up before the transaction took place.
A limit buy would work particularly well if you wanted to buy an infrequently traded share, where it's hard to predict what price you might otherwise pay.
However, you'd be wise to keep an eye on your limit buys, which last for 30 days unless you cancel them. During that time, a company might announce some bad news, and the share price falls. You would end up paying your price on the way down, where otherwise you would probably have waited until the price settled.
Also, as you realise, if you set too low a price, you won't get the shares. If you really want a certain share, you have to set the limit close to the current price or the purchase might not happen. That means that although you get a bargain, it's not a big bargain.
But if you're less fussed about what you buy, you could put in low limit buy orders for lots of shares and end up with the ones that got cheap enough.
Would that randomness matter? Perhaps not. I've written before about how monkeys have picked shares — or people have thrown darts at a newspaper share table and bought whatever they hit — and done better than people who spend hours agonising over what to buy.
So what's my opinion? By all means use limit buys, as long as you're watchful. Buying bargains is good — although I doubt if it will make all that much difference over the long haul. By the way, ASB, Hatch and perhaps other sharebrokers also offer limit buys and sells.
Footnote: Suddenly I'm getting questions about share trading. That hasn't happened for a while. It's good to see, as long as people are buying for the long term, as you are. Short-term trading doesn't work out well for most people.
- Mary Holm is a freelance journalist, a seminar presenter and a bestselling author on personal finance. She is a director of Financial Services Complaints Ltd (FSCL) and a former director of the Financial Markets Authority. 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. Send questions to email@example.com. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.