Better to be safe, but not too safe

By MARY HOLM

Q. Many people would agree with your "house built on an old tip site" buyer, that one should carry out careful checks before a major purchase. But why stop with the council?

To be really safe you should also have structural, plumbing, drainage, electrical, groundwater, geological reports and probably a cultural audit would be wise too (though this may be no longer necessary "post Brash"?) It is true that any specific problem could have been avoided if one had checked for it in advance. But at what cost?

I'm semi-retired and most of my friends are nearing that stage, and your article started me thinking back.

I observe that those who have lived cautious lives have not had noticeably fewer problems than those who were more impulsive, the reverse actually. And the cautious are generally poorer.

I don't think this is due to chance, rather it is that the cost of missed opportunities is much greater than the cost of overcoming mistakes.

Life is full of uncertainty, and attempts to make it less so rapidly come to cost more than the benefit. Too much insurance guarantees you'll stay poor.

A brief check for the obvious problems followed by a quick decision to "seize the day" and a willingness to ride out the mistakes and move on cheerfully seem to work better.

A. If my article got you thinking, your letter got me thinking.

You're quite right. Journalists often tell readers to check everything out, heedless of the fact that that takes time, energy, money and often worry.

As an old Chinese proverb says: to be uncertain is to be uncomfortable, but to be certain is to be ridiculous. I'll try to avoid ridiculous suggestions in future!

Your claim that the cautious are generally poorer certainly seems true if we look at investments.

I recently saw some figures that showed someone who invested $10,000 in New Zealand shares 30 years ago would now have more than three times as much as someone who put the same amount in bonds. In world shares, they would have almost five times as much.

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Q. In

last week's column

you said $19,000 in the share market in 1968 would be worth $235,000 today.

Isn't there a flaw in the calculation? By using the NZSX40 year on year you don't take into account the companies that have disappeared from the index, eg in 1987.

Using the index to me is like tracking only the most successful race horses each year since 1968.

Am I right or do I not understand the index?

A. You don't understand the index.

What you're worried about is what is sometimes called "survivor bias".

It happens when a researcher looks back on the performance of, say, New Zealand share funds over the past 10 years, or hedge funds over the past 5 years.

The researcher will typically look at returns on all the funds that have been around over that period. They generally exclude funds that closed down before the 5 or 10 years was up.

The trouble is that those funds probably closed because they weren't doing well. The failures are excluded, so the research results make average performance look better than it really was.

A share market index like the NZSX40, though, is calculated day by day, warts and all. You get the same sort of ups and downs as a typical diversified investor might get.

Within the index, over the years, a few companies rise from number 40 to number 1, although most stop somewhere in between. At the same time, other companies fall from high places to low and, regularly, some fall off the bottom.

Sure, they then disappear. But, to balance that, growing companies don't enter the index until they are 40th biggest. Before that, they have made huge growth that is also not captured by the index.

You could argue that we should use the index that covers the whole share market, the NZSX All. But that hasn't been around for nearly as long as the NZSX40 and its predecessor, the Barclays Index, so there's less data.

In any case, the broader index will always behave very similarly to the top 40 index, as our graph shows.

That's because all the indexes are weighted by each company's market capitalisation (number of shares times the value of each share). So the bigger companies dominate.

The graph also shows, by the way, that the All index has outperformed the NZSX40 since 1991. This means that companies smaller than the top 40 have done better than the big ones.

This probably largely reflects the fact that smaller companies are riskier, and hence you would expect a higher average return.

It's dangerous, though, to expect the smaller ones to always do better. There are quite often prolonged periods when the opposite occurs.

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Q. Using the excellent

CPI calculator you recently recommended

, I inserted the $19,000 in mid 1968 to find the present value of that investment.

Surprise, surprise! It comes to more than $245,000, which means that in real (inflation-adjusted) terms the capital index, now at $235,000, has shown negative returns before dividends over that period.

This as you know will make it very hard for long-term savers to prosper by investing in this market.

What am I missing here - or is it simply true that the New Zealand market has provided very good returns to all but the investors?

As Buffett has said, "what's good for the croupier is not always good for the gambler".

A. You're right that shares without dividends have risen less - although only a squidgeon less - than inflation. But:

* The period included the unexpected inflation that resulted from the early 1970s oil crisis and the high inflation of the 1980s.

Given that, shares did pretty well.

Shares and property are the only mainstream investments that had a chance at keeping pace with inflation over that period. You would have done much worse in term deposits or bonds.

* Ignoring dividends on a share investment is like ignoring rent on a property investment.

When you include reinvested dividends, as I said last week, after tax you would have about $925,000. That's way ahead of inflation.

You could argue that not everyone reinvests their dividends. Nor does everyone reinvest interest on term deposits or bonds.

If you didn't do the latter, your $19,000 in 1968 would still be $19,000. Talk about long-term investors not prospering!

I discussed all this with Michael Chamberlain of MCA NZ, who gave me last week's figures.

He adds: "When an investor is making a decision about strategy they need to start with what income return they want, what growth they want, what inflation protection they want, and select investments accordingly.

"Overseas companies tend to retain more profits [and not pay them out as dividends], and therefore have a higher growth component and a lower income component than New Zealand companies.

"Also, overseas shares give protection against imported inflation. This is why most investors should have an exposure to global shares as well."

One more point: if you invest in bonds, you can build in some protection against expected inflation by reinvesting some of the bond interest. But, as Chamberlain says, "this doesn't protect you against unexpected inflation."

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