A Reserve Bank stress test showed that if house prices tumbled, banks' earnings would act as a buffer and they would remain solvent. Photo / NZME
If you thought that housing prices could drop by 40 per cent, as discussed recently in the Herald, where would you suggest keeping your money?
Banks could be a bit stretched, to say the least, but if you took your cash out of the bank to keep it safe, would you be better off in the sharemarket, foreign currency or gold? Where do people go with cash when times get tough?
A: Before we all empty our bank accounts and put the money into shares or something riskier still, let's look at how well the banks would fare if house prices plunged.
The short answer is "probably not disastrously".
Ironically, it's the shareholders in banks who are more likely to feel the effects, so moving your money into those particular shares could be a classic out of frying pan experience.
You're not the only one wondering about how a house price plunge would affect banks.
"The Reserve Bank runs periodic simulations to test the resilience of the New Zealand banking system," says a Reserve Bank spokesman.
"We recently reported the results of a stress test that assumed a severe economic contraction, with:
• Residential property prices falling by 55 per cent in Auckland.
• Residential property prices falling by 40 per cent outside Auckland.
• Commercial and rural property values falling by 40 per cent.
• Real GDP (gross domestic product) falling by 6 per cent.
• Unemployment rising to 13 per cent (up from a current 5.7 per cent).
• Dairy incomes remaining at low levels."
Sounds pretty dire. However, the test found that "while loan losses accumulated over three years until bad debts made up 4 per cent of banks' total lending, banks' underlying earnings acted as a buffer and absorbed the losses," says the spokesman. "In plain language, banks' profits declined and so they had to stop paying dividends to their shareholders -- but the banks remained solvent."
When I first saw that only 4 per cent of banks' loans would become bad debts, that seemed low. But when you think about it, even if property values plunged, the vast majority of homeowners and property investors would still make their regular mortgage payments.
Some recent purchasers would find their mortgages were bigger than their property value -- a situation called negative equity -- but that wouldn't apply to the majority, who have owned their properties for a while. In any case, even those with negative equity should just keep paying down the mortgage.
The ones who stopped mortgage payments would probably be mainly those hit by the scenario's big increase in unemployment.
To read more on the Reserve Bank's most recent stress test, see tinyurl.com/stresstestNZ. And to read the bank's six-monthly financial stability report, see tinyurl.com/stabilityreportNZ.
So, in answer to your first question, I would continue to keep the money I plan to spend in the next couple of years in bank term deposits.
As I said, shares, gold and foreign exchange are much riskier. Their values can soar or plunge.
Diversified shares are good long-term investments. And a bit of gold -- perhaps up to 5 per cent of your long-term savings -- can help with diversification. But don't get carried away with gold as some gloom and doomers do. Foreign exchange is a fool's game. While shares and gold tend to trend upwards over the years, forex can just as easily fall as rise.
But none of these investments is at all suitable for short-term money.
Q: I am retired and have spread my term deposits (each a six-figure sum) evenly between the main banks, so in the event of a banking catastrophe I have some degree of security. I have also split these savings so around half are PIE term deposits to gain some tax advantage.
As I am very risk-averse, I am wondering whether the PIE term deposits are less secure than the ordinary term deposits in the event of a bank collapse.
A: Says the Reserve Bank spokesman: "A bank PIE cash deposit is no safer or riskier than a standard term deposit from the Reserve Bank's regulatory point of view.
"In the extremely unlikely event of Open Bank Resolution being required, PIE deposits are not treated any differently than other deposits."
Open Bank Resolution takes place if a bank fails. A portion of your deposits will be frozen, and you may later lose that money. But the bank will open next morning and you will be able to access the rest of your money.
All accounts, including transaction and on-call and other savings accounts will be affected.
In light of this -- "extremely unlikely" though it is -- it's not a bad idea to spread your money around several banks, especially with deposits as large as yours. In any case, it helps you keep track of which bank is offering the highest interest lately.
Q: I don't want to bother you, but I have just watched the video attached talking about the world markets and the "coming collapse"?
If you have half an hour spare watch the video titled "CIA Insider Breaks Silence on Currency Wars" below.
A: Sorry, but I would have to have a great many spare half hours before I watched this.
The website is called Prophecy News Watch and it bills itself as "world events from a biblical perspective".
As I've said many times, financial trends can't be accurately forecast. I've seen people consult data on sunspots and the lengths of women's skirts to predict the sharemarket. Why not the Bible? Because none of them works.
Q: I am trying to convince my husband that most of our savings should be with a financial institution that invests in diversified index funds (we are in our 40s with a mortgage-free house).
He worries that if the financial institution (for instance, SuperLife) goes bust in another global financial crisis, say, then we will lose everything. Is this a realistic possibility, or are we somehow protected?
If not, does the principle of diversifying mean that we should spread our money across several institutions? That seems inefficient in terms of fees.
A: Oh no, not another doom and gloom question! We must be in the depths of winter or something.
But first, I like your choice of investment. You've got your accommodation taken care of, and you have plenty of years before you're likely to spend your savings, so there's time to ride through the ups and downs of sharemarkets.
And index funds -- which simply invest in the shares in a market index and so are cheaper to run than actively managed funds -- tend to charge lower fees.
The big question is do index funds, whose performance closely follows the market, perform as well as active funds, whose managers pick stocks that they hope will outperform the market?
Lots of research -- mainly in the US -- shows that while some active managers beat the market every year, they don't continue to do so. Indeed, recent high flyers, who may tend to be bigger risk takers, have a tendency to be next period's crawlers.
A financial writer in Time magazine recently wrote: "By now, we know that beating the market is impossible, and we should steer people towards the things we can control -- diversification, low costs and good savings behaviour over long periods of time, through many market cycles."
New Zealand fund managers often say our sharemarket is not as scrutinised as the American market, so their experts can ferret out good local buys and sells.
There's probably some truth to that. But how do you pick which active NZ share fund to invest in?
Says the NZ Super Fund (or Cullen Fund), which has performed impressively: "True skill in generating active returns versus a manager's benchmark ... is very rare. This makes it hard to identify and capture consistently."
My preference is to go with index funds for both New Zealand and international share investments. For more on this, click on "index funds" on the left side of www.maryholm.com.
Moving on to your husband's worries, managed funds -- which include index funds -- are considerably less risky than the finance companies that went belly up a while back.
Those finance companies often put people's money in projects such as property developments, which were riskier than they made out. Or they lent money to "related parties" without disclosing that. And often their investments were seriously undiversified.
On the other hand, fund managers -- KiwiSaver providers and others -- use many different investments that are not related to the fund management firm. And each fund manager appoints a supervisor, a separate company, to make sure your money is invested where they say it is.
That means that if the fund manager got into financial trouble, that shouldn't affect the investments.
What's more, there's a lot more scrutiny of this process than there used to be. Both the fund managers and supervisors are monitored by the Financial Markets Authority. I would be really surprised to see New Zealanders lose money in a mainstream managed fund because of wrongdoing.
Of course, all of this has nothing to do with how the investments fare. In a share fund your investment will fall sometimes, but as long as the fund is widely diversified -- which is pretty much always the case -- history tells us that, if you stick with it, your investment will rise again, even if it takes a few years.
You have to take a few risks in life if you want to gain much. It's a bit like riding in a car. You could stay home and stay safe, but miss out on much.
On spreading your money around a few different fund managers, that would turn a low risk into a really low one. But as you say, fees could be higher, and there would be a bit more hassle.
Up to you.
Q: I read your comments last week on "laddering" investment terms and intend doing just that.
At present all my savings are in my KiwiSaver account, which I have chosen to continue with up to now as my employer has continued to contribute in spite of the fact I have reached 65-plus. Is this the wise thing to do?
I am considering taking a partial withdrawal from KiwiSaver (conservative fund with AMP) and trying the laddering approach. Your thoughts please.
A: Phew, a happier reader at last -- or at least you should be given that your employer is still contributing to your KiwiSaver account after you've turned 65.
Yes, definitely stay in the scheme. While your tax credits stop at 65 -- unless you've been in KiwiSaver for less than five years -- it's well worth getting employer contributions.
But it's also a good idea to put the money you plan to spend in the next couple of years in bank term deposits.
Even in a conservative KiwiSaver fund, your balance will fluctuate a bit, and you want your spending money to be fixed.
And laddering the term deposits works well, as I explained last week.
OPINION: You need to consider interest, taxes and fees.