In response to the reader's question last week about who worries most, the retired person with money or the one with no money, I know that in the US many people who retire wealthy or well-off bought that used car or $30 watch instead of the Rolls-Royce version.
Most people who accumulate wealth are good at not spending or living beyond their means. No doubt it is similar here. I heard a man at the supermarket checkout the other day complaining that as he neared retirement, he could not save. This as he was buying cigarettes.
Careful! It's too easy to get judgmental about how others spend their money - although I suppose it's fair enough if they complain about their inability to save.
Anyway, I like your main point. In a fascinating book called The Millionaire Next Door, authors Thomas J Stanley and William D Danko say that many of America's wealthiest people live modestly.
Professional people - doctors, lawyers, accountants and so on - often seem to be wealthy, but they have borrowed lots to finance their flash houses, cars, clothes and holidays. Their net worth - assets minus debts - may be low, say Stanley and Danko. Those with high net worth are often businesspeople who live quietly in the house next door.
The most famous case of the frugal billionaire is hugely successful share investor Warren Buffett. According to Investopedia, Buffett still lives in the house in Omaha, Nebraska, that he bought in 1958. "He is well known for his simple tastes, including McDonald's hamburgers and cherry Coke, and his disdain for technology, including computers and luxury cars."
That's not to say frugality is everything. What's the point in wealth if you don't enjoy it? There's a happy medium.
Fees seem high
Over the past year the NZX50 - which measures the growth of shares in New Zealand's biggest listed companies - has gone up by 13 per cent. Most managed funds will count themselves lucky to have got half of that.
This tends to confirm your advice (and Warren Buffett's) that passive index-linked funds are a better bet than actively managed funds. So far, so good.
But why are there so few index-linked funds in this country? Even more important, why do the fees seem so high?
One I was able to find charged 0.75 per cent, admittedly half a per cent less than an active fund. But when the investing strategy seems to be to maintain a portfolio that is based on holding the NZX50 shares in the same ratio as their share of the market, you might think it would all be computerised and require very little hands-on management. Surely that should translate to much lower fees?
Ever noticed that most good and bad differences between New Zealand and Australia or the UK or the US come down to our smaller population?
It's easier to find an empty beach here. But most journalists can't spend several months investigating a story.
Same goes for index fund fees. They're high by international standards - even though they are considerably lower than active fund fees - because the funds are smaller. There are fewer investors to spread the costs over.
The fund you're referring to is the NZ Top 50 (FNZ) fund, run by Smartshares, New Zealand's main provider of index funds.
Its 0.75 per cent fee is one of the highest Smartshares' fees. Some of their other New Zealand and Australian share funds charge 0.60 or 0.54 per cent, and their New Zealand cash fund charges 0.33 per cent. Still, the fees are much higher than in the US.
Also, if you invest directly with Smartshares and your first investment is less than $20,000, there is a one-off $30 application fee. But "there are no transaction fees on any additional lump sum or regular savings plan contributions", says a Smartshares spokeswoman.
Alternatively, if you invest via a sharebroker - which you can do because Smartshares are traded on the NZX stock exchange - there's no application fee. But you'll pay brokerage, typically a minimum of $40 to $70.
Smartshares says the average size of its 23 ETFs (exchange traded funds) is about $61 million, compared with more than $160 million in Australia.
The spokeswoman adds: "Smartshares has signalled to the market that fees will reduce as scale grows, and this is demonstrated with all of the new funds launched in the past 18 months having a management fee of 0.54 per cent or less."
Fingers crossed for fee cuts soon. And read on.
Can you please indicate if it may be better to hold ETFs via Smartshares or through SuperLife's MyMix portfolio.
Your question introduces a third way to invest in Smartshares - in addition to directly or via a sharebroker.
SuperLife is a superannuation and KiwiSaver provider. Like Smartshares, it is now a subsidiary of NZX. If you invest in SuperLife, you are actually investing in Smartshares' funds, but via a different vehicle.
With both direct Smartshares and SuperLife investing, you can start with just $500 and add as little as $50 a month. You can reinvest your dividends - a great way to help your savings grow. And you can withdraw money relatively easily (unless you're in SuperLife KiwiSaver).
So, is SuperLife a better way to go? It depends on your circumstances.
Looking at fees, "The ETFs through Smartshares are at retail investment management rates and through SuperLife are at wholesale rates," says SuperLife co-founder, Michael Chamberlain. "Even with our administration costs, the NZ Portfolio ETF, for example, is 0.40 per cent through SuperLife and 0.75 per cent through Smartshares.
"The new Smartshares ETFs are slightly cheaper than the older ETFs, but still slightly higher than SuperLife's fees."
Unlike Smartshares, however, SuperLife charges an annual membership fee of $33. If you are making a small investment, this could tip the balance in favour of investing directly in Smartshares.
Chamberlain continues: "The SuperLife service is also more comprehensive in that you get a website to track your investment, a smart phone app and regular statements."
Also, "Smartshares only has 28 per cent PIRs and so you have to apply for the tax back if you are on a lower rate." In SuperLife, you can have tax deducted at your correct PIR rate.
On the other hand, says a Smartshares spokeswoman, people who buy and sell Smartshares units via their sharebroker have "the ability to see their ETF holdings alongside their other shareholdings, and use margin lending for ETF purchases or setting buy and sell prices.
"The second major difference is when investing in Smartshares directly, an investor can do so via different investment vehicles such as individuals, partnerships, family trusts or company."
Letter from Andrew Coleman, senior lecturer, University of Otago Department of Economics
A while ago you printed my response to a question about the way lenders pay too much tax when there is inflation. One way to solve this problem is to only tax the inflation-adjusted component of interest. This means that if the interest rate is 5 per cent and inflation is 2 per cent, you would only tax 3 per cent.
Do many countries do it? No - but this is because the problem is much less severe in most developed countries than in New Zealand because of the way they tax retirement savings.
It is worth looking at what these countries do, as it provides a different way of solving the inflation tax issue.
There are two quite different ways to tax income: when it is earned (income taxes), or when it is spent (consumption taxes). New Zealand has income taxes and GST.
Tax experts agree that income taxes are more distortionary than consumption taxes, mainly because they distort the way people invest, as different assets are taxed differently.
To reduce these problems, most OECD countries have tax rules for retirement saving that make income taxes much more like consumption taxes.
In a typical OECD country, people are allowed to place some proportion of their labour earnings in a special retirement income - in the US this is a 401k account.
They do not pay tax on this income when they place it into the account. If, for example, they earned $80,000 and placed $10,000 in the account, they would only pay tax on $70,000. Nor do they pay tax on any interest, dividends or capital gains earned in the account while the funds are accumulating.
However, they pay tax (at their income tax rate) when funds are withdrawn from the account.
This system is called EET for "Exempt-Exempt-Taxed". New Zealand used this system until 1989, but since then we apply TTE or "Tax-Tax-Exempt" rules to all saving and investment.
The EET system has three advantages:
• It doesn't matter what investments you choose in your retirement saving account - it is all taxed the same. Thus the tax system doesn't affect your choice of retirement saving investments.
• The effective tax rate on an EET retirement scheme turns out to be the same as the tax on your own house, which is taxed on a TEE (Tax-Exempt-Exempt) basis. (See if you can work this out!). This means there is no tax advantage between buying a bigger house or investing more in your retirement account - something that is not true in New Zealand, where we favour housing.
• Inflation does not affect the after-tax investment returns in the retirement account. In most OECD countries, most people have most of their retirement savings (other than their house) in one of these accounts. This is why these countries have less need to adjust interest earnings for inflation before they are taxed.
The system isn't perfect, as there are different taxes for savings held inside the retirement income account and other non-housing savings. For most people, however, the system is less distortionary than our system, and it helps them beat the inflation tax.
New Zealand is quite unusual in the OECD. By taxing income when it is earned, not when it is spent, we have low income tax rates - but this comes at the expense of increasing the way the tax system distorts investment decisions. It is bad for lenders, and favours people who own their own houses.
And since there is little political demand to change how we tax retirement savings, there is a greater need here than elsewhere to tackle the problems caused by taxing the inflation component of interest income.
Interesting stuff. Not a light Saturday morning read, but worth thinking about - especially by politicians.
Did you take Andrew's challenge, and work out why EET is the same as TEE? Let's say you have income of $1000. Under EET, you invest the full $1000, and we'll say it doubles over several years to $2000. That is then taxed on withdrawal - say at 30 per cent. So you are left with $1400.
Under TEE, your $1000 is taxed at 30 per cent at the start, so you invest $700. That doubles to $1400, which is not taxed when you withdraw it. So you are also left with $1400.