Money: Hang on in there for the long haul

Q: I see that you are still maintaining that investors should buy shares for the long haul, and that in the end any short-term falls in value will be recovered.

Why is it then that about half the shares on the New Zealand Stock Exchange are sold every year? In other overseas exchanges the turnover can be 100 per cent or more.

This seems to indicate that funds managers, rather than investing for the long term, are churning away like mad. Please explain.


A: Henry Ford, caught with a woman who wasn't his wife, said, "Never explain, never complain" - or so the story goes. But I'm going to do both.

First, the complaint. I have never said of individual shares that "short-term falls in value will be recovered." You don't have to look far to find shares whose value has fallen to zero and stayed there.

I always suggest investing in a wide range of shares, directly or through a managed fund.

If you do that, the value of your whole portfolio or your managed fund investment will almost always rise if you hang in there for long enough - even though some of the individual shares turn out to be duds.

Now the explanation. For starters, I don't know if we should conclude that fund managers are the ones doing all that trading.

According to Deutsche Bank, in July New Zealand institutions - the domain of the fund managers - owned just 14 per cent of New Zealand shares, and overseas institutions owned 31 per cent. In total, fund managers owned less than half of all the shares.

Deutsche Bank also said that overseas corporates owned 23 per cent; local corporates 7 per cent; private clients 19 per cent; and other substantial New Zealand individual holdings 5 per cent.

Some of these other groups could well be responsible for more than their fair share of trading, says Paul Dyer, AMP Henderson's head of investment strategy.

"Professional fund managers' performance is monitored. If they turn over their shares excessively, their returns will be lower. Individuals have no such discipline."

He adds, though, that for fund managers, "keeping turnover down to zero is impossible."

In active funds, in which the managers select shares, their role is to buy and sell as opportunities arise.

Given all their research facilities, they presumably get a better run at share selection than the average individual.

Still, their decisions don't always turn out to be wise, and sometimes they are trading rather desperately to try to turn around a bad performance.

The very frequency of trading by some active fund managers is one reason I prefer passive, or index, funds. In those funds, the managers don't choose what to buy. They simply hold the shares in a share market index.

Even in index funds, though, "the turnover is a surprisingly high 5 to 10 per cent of the fund per year," says Mr Dyer. "Companies are dropping in and out of the index; there are takeovers, share splits and amalgamations."

There are good and bad reasons, then, for fund managers to trade shares.

Regardless, individuals are better off buying and holding.

This is partly because it costs lots to trade. Every time you do, you have to pay brokerage and, perhaps, tax on your capital gains.

Also, people frequently trade in reaction to short-term market conditions. And numerous pieces of research show this is not clever.

For instance, BT Funds Management compares two investors who each put $20,000 into BT's international share fund in December 1986.

One got out of the fund after the 1987 sharemarket crash and came back in when markets looked better. He did the same when the market fell because of the 1990 Gulf War, 1997 sharemarket "correction" and 1998 Russian collapse, each time buying back in when things improved. In September last year he had $92,710.

The other investor stayed in the fund throughout. His September 1999 total was $185,368, almost twice as much.

Probably the best-known advocate of buying and holding is American Warren Buffett, said to be the most successful investor of all time.

Q: In "Money Matters" on December 2-3, your correspondent said, "Next you'll be suggesting the introduction of a window tax to stop people enjoying natural light."

Such a tax would not be new. It was introduced in Britain in 1696, originally to cover losses in the coinage through clipping and wear (edges of coins were not then milled).

It was imposed on "windows or lights." Extra-large windows over 12 feet high were charged as two. The rates were initially 2 shillings per house, plus 4 shillings if the house had between 10 and 20 windows, and 8 shillings for more than 20 windows.

On February 8, 1748, in the Budget speech in the House of Commons, Mr Fox agreed that "no minister will dare increasing either the land tax, the window tax or the number of our excises."

While it was in operation it was opposed by many property owners, who adopted the then equivalent of tax avoidance by removing the glass and bricking up the spaces. Many of your readers will have seen the results during their travels.

The tax was abolished in 1851, being substituted by house duty.


A: We've had Shakespeare in this column before, so why not a history lesson?

Another reader wrote along similar lines. "I remember a house in Galway," he said, "built with very small windows because of the dreaded tax, which gave rise to the term 'daylight robbery'."

My own research uncovered a similar tax in the US, brought in at the end of the 18th century.

Q: In spite of the probability you have had enough of the capital gains on housing discussion, I would like to respond to a couple of issues.

First, Gareth Morgan is wrong about rising rates (on properties) being a function of value and somehow thereby equating to a tax.

They are not. They are a function of the rating authorities' desire to spend money. They levy rates at whatever percentage of property value is required to meet their budget.

That we all end up paying higher rates is a truism and applies where values are rising and falling.

Secondly, to tax increases in property value implies, in equity, that losses in value should be refundable, which would put the Crown in the position of underwriting the value of home purchase costs. This would be most welcome to the many tens of thousands of rural and provincial city owners, such as those in Invercargill.

As an aside, there seems to be an almost universal belief that all home owners make money.

You should take the trouble to talk to owners in the North Island ex-logging towns and other provincial centres to find falling values have been more the norm.

Finally, you state that rational people are currently spending more on their homes than on investments with taxed returns, with implied detrimental effects on the markets.

I dispute this. As a long-term share and property owner, my tax position on any gains is the same between the shares and my property. Income from both is taxed.


A: Of course income - in the form of rent and dividends - from both is taxed. But the capital gains situation is less clear.

Capital gains on property are generally not taxed. Capital gains on shares sometimes are. And capital gains on many share funds are always taxed, at the fund level.

If you are a long-term direct holder of shares, you might escape all tax on capital gains. But that's not true for others with different investments. It's this uneven treatment that distorts people's investment decisions. Given the tax system, they would be silly not to put more money into tax-favoured investments than they otherwise would.

But, it seems fair to let economist Gareth Morgan respond.

"Rates are a tax on wealth," he says. "The higher the value of your property is relative to others, the greater your share of the rates bill will be.

"The debate about taxing capital gains is about finding the most equitable tax base to apply taxation to, for the purposes of funding Government spending.

"Obviously if Governments didn't spend we wouldn't have to bother, just as if councils didn't there would be no need for rates. But that is not what the discussion is about."

Moving to your second point, yes, if capital gains on a house or anything else are taxable, capital losses should be deductible.

That's what happens now for traders and others who pay tax on capital gains on shares. They deduct their losses. That doesn't mean the Crown is underwriting those investments.

As for your statement that it's an "almost universal belief that all home owners make money," just last week I said in this column, "In the past three or four years, most property values haven't gone anywhere much. Some have fallen."

For good measure, I'll throw in some comments from Mr Morgan on the recent OECD recommendation that New Zealand should tax capital gains, as most other countries do.

"Our Minister of Finance has rejected that advice, essentially saying that he is not sufficiently competent to 'sell' the idea to his colleagues, nor to the public.

"That's sad, because not only would its inclusion enable people to make investment decisions for economic rather than tax reasons, but the wider base would enable the average tax rate to come down for all."

Mr Morgan concludes, "Lack of gumption to promote the argument seems to me a costly form of political negligence. It encourages a continuation of over-investment in less-productive, but more tax-favoured assets like land."

Hear, hear!

* Mary Holm is a freelance journalist and author of the newly published Investing Made Simple. Send questions for her to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@journalist.com. Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number in case we need more information. Mary cannot answer all questions, correspond directly with readers, or give financial advice outside the column.