The Best Way to Invest for Your Children in New Zealand Part 2- What to Invest

This is the second part of my investing for children series. In a previous post, we talked about why should we invest for your kids and what you need to know beforehand. Now, let’s dive into what to invest for your children in New Zealand.

Index Fund & ETF for Kids

In case you don’t know, I am a big fan of the low-cost index fund and ETF because this is a low-cost investment option with a diversified portfolio and low entry requirement. Naturally, I will put my kid’s investment into them as well as a managed fund with ETF and Index fund in it. However, lots of investment services won’t accept anyone who is under 18 years old as investors. Basically, under their terms and conditions, you will have to be 18 years old or over to sign that agreement. Therefore, there are not a lot of choices for children.

 

7PhLQGY.gif
Looking for investment options for my kids

Furthermore, a good investment for kids is kind of the hidden gem out there. The one that advertised heavily aren’t very good, and you will have to dig deep to find the good ones. After lots of googling, emailing and reading, here are my top picks.

SuperLife MyFutureFund

Hidden Gem No.1 is Superlife MyFutureFund. This is a different service from SuperLife KiwiSaver and SuperLife Invest (non-KiwiSaver Service). This service doesn’t have a web page at the moment so you won’t find it on SuperLife web site. The information is buried under SuperLife Invest Product Disclosure Statement, page 26 and 27 of that PDF file.

(Superlife is currently redesigning their web site. MyFutureFund page will return after that.)

MyFutureFund itself is NOT an index fund or managed fund, it’s just a way that allows children to invest in SuperLife’s product. The account is in the child’s name but the guardian/person opening the account has control of the account including access to the funds through until 18 years of age. The account is separate from parents account, but you would be able to view the account through a “linked” membership.

MyFutureFund has access to the all Superlife investment options. There are over 40 different investment options available for kids including ETF, index fund, sector fund and managed fund. My personal picks for my kids are SuperLife 100 and Overseas Shares (Currency Hedged) Fund.

SuperLife 100 is made up of mostly Vanguard Index fund and ETF plus fund from Somerset. The investment included, 55% of international shares, 33% of Australasian shares and 12% listed property. The management cost is 0.52% and risk indicator at level 4. Three years return after tax (PIR at 28%), and fees are 8.35%. Seven years return is not available.

Overseas Shares (Currency Hedged) Fund is made up of eight Vanguard ETF. Invested 100% in international shares and mainly in US and Europe stock market. The management cost is 0.48% and risk indicator at level 4. Three years return after tax (PIR at 28%), and fees are 7.52%. Seven years return is 11.47%.

I picked those two funds because they are both diversified and contain 100% growth asset. Regarding fees, the management fees are relatively low, and SuperLife’s annual admin fees are only $12/years. They do not have regular contribution requirement, minimum investment amount can be just $1. So Superlife is great for both regular and irregular investing for your kids. I already got an account with SuperLife on my own so linking the kid’s account is straightforward and easy.

What about Investment for Mid-term

Those two fund that I suggested were 100% growth asset, so they are aggressive fund. They provide a great return on long-term investing. However, they will be too risky for mid-term investment. If you plan to use that money within 4-10 years, you may consider some other fund with lower growth asset.

SuperLife 30, 60 and 80 are similar to SuperLife 100 but added a different percentage of income asset. Fund with more income asset will have a lower range of gain and loss in any given year, and better return during recession compare to 100% growth asset fund. On the other hand, when the market is booming, that fund will have a lower return.

I think Superlife 30 will be ideal for 4-6 years investment, Superlife 60 will be great for 6-8 years, and Superlife 80 will be ideal for 8-10 years. For example, if your kid is 12 years old and planning to use that money for the university at 19-year-olds. Your investment timeframe will be 7 years, and you should consider Superlife 60. For any plan under 4 years, term deposit with the bank is a good choice.

How To Join MyFutureFund

SuperLife doesn’t have the easiest way to join so there is how you can join them. You will need to fill in the application form from SuperLife and send it over by mail or email.

  1. Download and read SuperLife Invest Product Disclosure Statement
  2. Go to Applications form (page 22 of the PDF file) and fill out your kid’s details and use a separate email set up for kids investing.
    Screen Shot 2017-09-11 at 10.35.29 PM.png
  3. Under Saving section, you choose how you are going to invest. It can be one lump sum investment, regular investment or both. The example below starts with $500 lump sum investment with NO regular contribution.
    Screen Shot 2017-09-11 at 10.45.08 PM.png
  4. Fill out the Communications and ID verification. You should be using NZ passport or NZ Birth Certificate for the kid.
  5. Under Investment strategy, they will ask if you would pick their managed fund first.  If you wish to join SuperLife 100, just tick as below.
    Screen Shot 2017-09-11 at 10.50.27 PM.png
  6. If you wish to join other funds or join multiple funds, you’ll need to tick “My Mix” and go to the next page.
  7. At page 5 of the application form (page 26 of the PDF file), fill in initial investment or regular investment. You can set the amount by actual dollar value or by percentage. At the example below, I invest 50% to Superlife100 and 50% to Overseas Shares (Currency Hedged Fund).
    Screen Shot 2017-09-17 at 10.11.54 PM.png
  8. On the right side of My Mix page, you can decide what to do with your investment income. They can be reinvested into the fund or save the return in cash fund. Reinvestment is the most common choice for kids. Below that, you can decide rebalancing options, I suggest to use the standard rebalancing for the kids.
  9. At the next page (page 25 of the PDF file), after you pick the beneficiaries (usually “My estate”), DO NOT sign at the bottom. You should move onto the next page.
    Screen Shot 2017-09-17 at 10.36.14 PM.png
  10. At the next two pages (Page 26 and 27 of the PDF file), you will have to fill in your own information as the guardian, supply the ID information, and sign it.
  11. Once you completed the application form, you can send it over to SuperLife, and the investment account will be ready in a couple days.

If you have any other questions, contact Superlife with superlife@superlife.co.nz or call them at 0800 27 87 37.

InvestNow’s Vanguard Fund

The second gem is InvestNow. InvestNow is an online investment platform provides multiple investment funds for their investors with low entry requirements and no middle-man fee. You can check out my blog post on InvestNow here. Unlike other investment services, InvestNow’s term and condition do not have an age restriction. Therefore, InvestNow opens the door are a whole range of investment fund for your kids. You can check out the full range of investment fund from InvestNow here.

Screen Shot 2017-09-17 at 10.42.19 PM.png

Out of all those investment options, my pick for my kids is Vanguard International Shares Select Exclusions Index Fund.  That fund launched for AUS and NZ market in late 2016. It contains about 1500 listed companies across 20 developed international markets (without Australia). This fund is an ethical fund as they excluded Tobacco, controversial weapons and nuclear weapons investment.

The BEST things about this fund are the cost. It only charges 0.20%/year on management fees and NO annual admin fee. The fund itself is a wholesale fund, which means it usually only accept institutional invest. The minimum initial investment required was AUD 500,000. The good news is, investors can join this fund via InvestNow with just $250 investment. (InvestNow will lower that requirement to $50 shortly.)

There is two version of this fund, one with NZD currency hedged with 0.26% management fee and one without currency hedged with 0.20% management fee. Without currency hedge, the fund is exposed to the fluctuating values of foreign currencies. So this fund will have a higher risk and lower cost. On the other hand, you will pay a higher fee for a more stable return with the currency hedged fund.

Here is the link to check out those two funds in details.

Vanguard International Shares Select Exclusions Index Fund

Vanguard International Shares Select Exclusions Index Fund – NZD Hedged

Pay Tax on Investment

Those two funds have a different tax treatment compare to normal PIE fund. With PIE fund, the investor usually just need to submit their IRD number and PIR rate once, then they don’t need to worry about tax. With those Vanguard funds in InvestNow, they are Australian Unit Trusts and will be taxed under Foreign investment funds (FIF) rule. Investors are required to submit their income from FIF and file a tax return every year. If the holding amount is under NZD $50,000, which should be the case for most children investors, you will need to pay tax on the dividend you received with the kids’ RWT rate. If the holding is over NZD $50,000, you will have to calculate your taxable income with either Fair dividend rate (FDR) method or Comparative value (CV) method.

For children investors with portfolio value under $50,000, filing a tax return on dividend received is not too hard. You will need to file a Personal tax summaries (PTS) with IRD, and it can be done online. I will share how I do that with my kids next year. Regarding FDR and CV method, I personally don’t know how to do it. You better to talk to a tax accountant for that.

How to Join InvestNow

InvestNow sign-up process is very straightforward so there won’t be a step by step guide. You’ll need to click on the join link on InvestNow home page and use a separate email address to sign up. After you sign up an account, InvestNow will ask you to provide information on identification. You don’t have to complete that. Instead, contact them directly with contact form or call them at 0800 499 466 and let them know you want to set up an account for your children. Make sure you got the following information ready

  • Email address of the account
  • NZ birth certificate or a passport for a child
  • IRD number of the child
  • PIR and RWT rate for the child
  • Proof of guardian’s address

InvestNow will be able to set up an investment account from here. They can also link multiple child accounts to your current InvestNow account if you have one already.

Update on functions

Currently (at 19 Sept 2017), InvestNow don’t have an auto-invest function, and the minimum transaction amount is at $250. So it’s not the best choice for someone who wants to regularly invest for their kids because they will have to transfer $250 into InvestNow, then login to their platform and manually invest that money into the fund. The Good news is InvestNow will implement auto-invest function and lower the minimum transaction limited to $50 shortly. So Investors can set up instruction to let InvestNow automatically invest into your preferred fund everytime you transfer money to them.

(Update, InvestNow added auto-invest function with minimum $50/transaction.)

Conclusion

Here is the breakdown of my top picks compare to our kid’s investment requirement.

Screen Shot 2017-09-19 at 2.43.56 PM.png

  • Superlife MyFutureFund provides a full range of fund for different investment timeframe. They have all necessary function for you to setup different investment plan for your kids. A great “set and forget” solution. However, they don’t have the lowest fee.
  • InvestNow allows user to invest in a great Vanguard investment fund with 0.20% management fee and no annual fee. However, you will have to do the tax return for your kid every year.
  • Feel free to contact them before you sign up and understand the process. I found both companies are great with answering customer questions.

In next part of my investing for kids series, we will look at some other investment options including KiwiSaver, Bonus Bond, SmartShares and more. If you are currently invested in or considering some investment program for your kids and want me to cover them, drop me an email at thesmartandlazy@gmail.com. I will try my best to cover that.

Breaking News: Happy Saver has a Podcast!

Attention all podcast lovers, for too long the NZ savings and early retirement community has been dominated by American, Australian and even British content and stories. While the principles of saving and investing are the same everywhere the specific examples of 401k accounts or Roth IRA’s or Australian self managed super are not that helpful in the NZ context.

Now that all changes, the fantastic Ruth has created a podcast to accompany The Happy Saver blog. 

Check it out on her site or subscribe via your preferred podcast app:

http://www.thehappysaver.com/podcast/

The Best Way to Invest for Your Children in New Zealand Part 1 – What You Need to Know

(This post was originally posted on thesmartandlazy.com on 12 Sept 2017.)

I am a father of two pre-school kids and I been researching on how to invest for them in New Zealand. There are some options out there, but the good one is surprisingly hard to find. So here is my finding on the best way to invest for your children and what you need to know.

There is a lot to write about investing for kids, so I am breaking this topic into three parts. I will talk about why invest for your children and what you need to know before investing here. Part 2 will be my pick on the best investment options for kids and part 3 will be my view on some other investment options in New Zealand.

Why Invest for Your Children

Education: The main reason I invest for my kids is that I want them to know about personal finance. I personally know a few smart and bright teenagers who are horrible with money, which leads them to big money problems (I used to work in student accommodation and know lots of students who left home and flatting with others). It seems like we don’t teach personal finance at school and we don’t talk much about money at home.  When some of those kids leave home, they have no idea how to handle money and make a mess with their finances. So for my kids, they will learn about personal finance from a young age. I won’t start them off the complex financial product, but eventually we will get there. That will be a great example to show how their own money is working for them.

Piggy-bank.jpg
We will start with a piggy bank first, but we will get to managed fund… eventually

Prepare for their future: I can’t predict whats going to happen in the future, so I want to do my best to prepare for it. For now, you can get an interest-free student loan for study, but it is not always the case. Student loan used to carry interest and before that, Univesity used to be free. For my kids, I have no idea what sort of society they will be facing, so it’s always better to have something prepared. No matter if they want to go to Univesity, go overseas, start their own business, there will be some money for them.

Best time to invest: There is a Chinese proverb said something like, ““The best time to plant a tree was 20 years ago. The second best time is now.”. For us, we can’t go back 20 years ago and invest for yourself unless we get our hands on a DeLorean DMC-12. At least we can do it for our kids. “It’s not timing the market, it’s time in the market.” By investing at their young age, that investment will have all the time in the world to grow and ride out of recession. It almost guarantees those diversified investments will have a great return once your kids reach adulthood.

Back_to_the_Future_2_Slider
You can’t go back 20 years ago to start investing, but you can do it for your kids.

There are two New Zealand personal finance bloggers wrote on this topic I think you should check them out. Ruth from the happy saver wrote a great blog post on ‘Teach kids about money’. Ryan from Money for Young Kiwis wrote another great piece on “Should you invest for your children”.

What do you need?

Before we go into the details, here is a checklist of what you need to set up an investment for your kids.

  • IRD number for the kids
  • Set up a new email account for kids’ investing purpose
  • Identification document for kids (Birth cert, Passport)
  • Identification document for guardian (Passport, Driver license)
  • Prove of relationship between guardian and child (Birth Cert)

Tax Matter

Some people think children do not pay tax as they have little or no income and that is not true. No matter how cute your kids are, IRD is going to charge tax on them. There is two type tax your kids will be paying, Resident withholding tax (RWT) and Prescribed investor rate (PIR).

Resident withholding tax (RWT) will be familiar to most people because you can see that on your bank statement when you received interest. Resident withholding tax is a tax deducted from a New Zealand tax resident customer’s interest income before they receive it. So it’s basically a tax on your interest and dividend received. Your kids will be using this tax rate if they earn interest from bank deposit or receive a dividend from shares.

Prescribed Investor Rate (PIR) is the rate at which an investor pays tax on their share of taxable investment income from a Portfolio Investment Entity (PIE) investment. It basically taxes on your investment funds like KiwiSaver, index fund and managed fund.

All investment service require IRD number so you MUST register your kid with IRD. If your children don’t have an IRD number, go to this website and get an IRD number for your child. You can check out IRD website to find out the correct RWT and PIR for your kids.

Tax Rate Difference between Adults and Kids

For most kiwi kids who have no income, their RWT and PIR will be at 10.5%.   This tax rate is important because average working adult RWT is at 30% or 33% and PIR at 28%. So kids pay much lower tax compared to an adult, and this is a great advantage for kids.

Some parents already set aside some money to invest for their kids under their name because of convenience. There is nothing wrong with that, but it’s not tax efficient. Let’s look at an example below:

Parent A and B both put $500/years into an investment fund with an average return at 7% after fees before tax. Parent A invested under their own name with PIR at 28%. Parent B invested under their child name with PIR at 10.5%. Here is the result after 15 years.

Screen Shot 2017-09-06 at 11.14.03 PM.png

Parent B’s fund ended up with a higher balance because it was taxed at 10.5%. The actual tax paid with PIR 28% was 1.4% of the fund and 0.525% with PIR at 10.5%. The different is just 0.875%/year. When the kids paid less on tax, more money kept in the fund to grow.  At year 15, it resulted in 7.39% different in value.

Remeber, your kids are NOT your tax shelter. Don’t put your own investment and life-saving under your kid’s name to pay less tax. IRD may treat that as tax evasion, and this is a criminal offence. When you invest for your kids, that money supposed to be their money or planning to use for them.

Skip the Bank Account

A popular thing parents do for their kids is to set up a bank account and put money into it for saving and earn a bit of interest. When I look at bank saving, it’s a safe option but not a good investment. Yes, you do earn interest from the bank, but the returns aren’t very good. Also, inflation and tax will reduce your return. You may get some interest on that money but it may worth less in the real terms after inflation.

Take a look at the interest rate on high interest saving account from January 2003 to August 2017 below.

Screen Shot 2017-09-07 at 11.34.03 PM.png

Before 2008, you can get about 4% – 8% interest on your deposit and now is above 2%. Let’s add tax and inflation to those interest rate. I will be using RWT at 10.5% as tax rate here.

Screen Shot 2017-09-07 at 11.38.55 PM.png

The green will be the real return on bank interest. It was around 2%-4% before 2008, dropped below 0% at 2010 and currently sitting just above 0%. Therefore, if you keep your kids money in the bank as ‘investment,’ the return is only a better than inflation.

For me, I will still open a bank account for my kids, but the purpose will only be temporary saving. The bank account is not an investment for my kids, it’s just a safe keeping.  Most of their money will be sitting in some funds.

Long-Term Investment

Some parents may think investment funds are too volatile for their own risk appetite, that’s why they choose saving account. This is true as saving account provide a low but safe return, investment funds’ return can range from 20% to -20% in a single year. However, we need to separate parent’s risk appetite with kids.

Kids have a lot more time ahead of them compared to their parents. For an average Kiwi kids in an average income family, here is a list of some life events that they may need to use that investment fund.

  • Pay for tertiary study at 18-20 years old
  • Moving out for job or school around their 20s
  • Overseas experience around their 20s
  • Buying their first home between 20-35

Most of those events happen around their 20. If you kids are under 10 years old, the investment time frame will be at least 10+ years for them. The common wisdom is you should take more risk when you have a long investment time frame. You shouldn’t worry too much about market downturn as they will definitely occur within their investment timeframe. By staying in the market for a long-term, you will ride out of the recession.

Investment Requirement for Kids

As we’ve established, Kids have different tax treatment, long investment time frame, and higher risk appetite compares to adult. Furthermore, Kids investment fund usually started with a small amount without regular contribution. Therefore, the investment requirement will be different as well. Here is a list

  • Age requirement: Must accept under 18 investor
  • Investment Time Frame: Mid to long-term
  • Risk: Medium to High
  • Asset mix: Mostly growth asset
  • Tax treatment: Prefer multi-rate PIE fund or RWT
  • Management fee: As low as possible (of course!)
  • Annual admin fee: As low as possible for good reason
  • Initial investment amount: As low as possible
  • Lump sum investment amount: As low as possible
  • Regular contribution: Prefer not to have regular contribution commitment

The reason we prefer not to have regular contribution is that kids don’t have a regular income. They may only get money once or twice a year for their birthday or Christmas gift. So we prefer an investment without regular contribution commitment, low initial investment and low lump sum investment amount. Parents and relatives can put in some money, no matter a little or a lot, whenever they want.

Watch Out for Annual Fees

Regarding fees, the amount of annual admin fee can be more important than management cost because that fund usually started with a small amount. When you investment fund valued at $20,000, that $30 admin fee is just 0.15% of your holding. However, if your fund valued at $500, that $30 admin fee will be 6% of your holding. Way more than the usual management cost you will be charged. So we prefer an investment with low annual admin fee.

Also, be aware if you started with a small amount and forgot about it for a couple years, the annual fees may eat up your entity portfolio. Check out the graph below on a small portfolio with $30 annual fees, 7% return after tax and management fee and with no further contribution.

Screen Shot 2017-09-12 at 11.24.35 AM.png

Screen Shot 2017-09-12 at 11.30.00 AM.png

For those portfolio balance with $200 or less, the annual fees will reduce your investment down to zero within 10 years. You won’t be able to keep your initial investment unless you start with $500 or more(based on $30/year annual fee and 7% return).

Therefore, if you plan to put some money in the let it sit for couple years without any contribution, you should start with $500 or more. If you plan to put some more money in at least once a year, you can start at around $250. Anything less than $200 should be kept in the bank. Also, pick an investment service with low or no annual fee will help.

What’s Next?

This is part one of my investing for kids blog. Next part will be my personal pick of the best investment options for kids and how to join them. Part three will be my take on other investment options in New Zealand.

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

One guide that all New Zealand investors should read

For years now one of the most sensible, reliable and accessible commentators on investing in NZ has been Mary Holm. She runs seminars, advises government agencies and working groups, writes a great column for the NZ Herald and is generally just New Zealand’s favourite financially savvy auntie.

New Zealanders are not always the best with financial literacy. We are often more scared than we should be of the sharemarket, we are famously not scared enough of piling ridiculous share of our wealth into investment property. We naively invested huge sums into dodgy finance companies and then the government had to bail us out to the tune of more than $1Bn!  We don’t tend to teach financial literacy at schools, except a few courses run mostly by banks, and many of us learned only the basics (or perhaps just bad habits) from our parents.

Thankfully the Reserve Bank is here to save the day.  As part of their focus on financial education they commissioned Mary Holm to write a simple booklet to make the complicated topics of saving, investing, and risk simple for everyday New Zealanders. It’s my favourite kind of book, it’s only 60 pages long, has small pages and has lots of pictures, tables and graphs to explain stuff.

Its available FREE to everybody on the interwebz right here on the RBNZ site:

https://www.rbnz.govt.nz/-/media/ReserveBank/Files/Publications/Factsheets%20and%20Guides/guide-upside-downside-a-guide-to-risk-for-savers-and-investors.pdf

Or, if you prefer the crisp feel of a page beneath your fingers. I have limited edition paper copy of the book that I can send out to one lucky winner. Just comment below with your saving and investing questions and I’ll randomly select one lucky winner to send the booklet to.

What’s not to love. A free book which was already free anyway.

Is now the right time to go solar?

Will solar power provide a better return than investing in the share market? Let’s take a look and find out.


I’ve been toying with going solar ever since I became a home owner 12 years ago. But I have never been convinced it was a good investment, well that all changed today. We’ve finally gone solar, and I’ll show you why.

My assumptions as at September 2017.

It costs $10,500 for 4.5kw of north west facing solar panels, and a solar power diverter installed in Christchurch, New Zealand.

Amount of solar power generated and consumed as calculated by the energywise solar calculator 3,090kw per year.

Price per kw $0.25 from current electricity provider.

3,090kw x $0.25 equals $772 of solar power per year.

By diverting excess solar power to heat our hot water cylinder, I estimated we will use an extra 1,000kw of our solar electricity per year.

1,000kw x $0.25 equals $250 of excess solar power heating our hot water per year.

$772 + $250 equals $1,022 of solar electricity generated and used per year.

Solar vs investing

$1022 dived by $10,500 equals 9.73% return on investment. Compared with a 7% average return from the share market, this is looking very good.

But wait it gets even better with the 0% financing and no repayments for 21 months being offered by select solar installers.

Instead of paying $10,500 up front for the solar install, say we take the finance deal and invested the $10,500 for 21 months.

$10,500 x 7%(long term average share market return) equals $735 return per year, divided by 12 months equals $61.25 per month x 21 months equals $1,286 earned during the interest free period.

$10,500 – $1,286 gives us the new cost of $9,214.

Let’s not forget we’ve also had the benefit of 21 months of solar power generation without paying a cent.

$1,022 of solar power generated per year dived by 12 months equals $85 per month, x 21 months equals $1,788 of free power.

$9,214 – $1,788 gives us a new price of $7,426 for our solar system.

The best return on your money

Thats right, you can get a 4.5kw solar system installed with no government subsidy for less than $7,500.

So what’s our new annual return on investment? $1,022 dived by $7,426 equals $13.76% return on investment per year, every year for the next 25+ years.

Expect regular updates as we monitor the solar systems performance and back this article up with real data.

Warning to all readers, beware of no interest deals, read the fine print and always repay in full amount before the interest free period is over.

“Fees never sleep.” – Warren Buffett’s bet

(The following article is an edited repost from the New Zealand Wealth and Risk blog.) 

I’m an Authorised Financial Adviser. For most of my clients, I advocate investing in low-cost, index-based investments.

I’m not alone. Warren Buffett is probably a bigger advocate than me.

In Berkshire Hathaway’s 2016 annual report, Buffett talks about index-based funds in detail.

I quote from Buffett extensively below, but you should really read the report yourself.

All emphasis is added.

Financial advice from Warren Buffett

Warren Buffett gives some clear financial advice:

“Over the years, I’ve often been asked for investment advice…. My regular recommendation has been a low-cost S&P 500 index fund.”

(I wouldn’t necessarily agree with this for NZ investors, but I agree with the key point: a diversified, low-cost index-based fund is generally a good way to go.)

Buffett’s bet

Buffett put his money where his mouth is and made a $500,000 bet that over an extended time period, a low-cost investment strategy would get better after-tax returns than a sample of hedge funds.

He provides background to his bet:

“In Berkshire’s 2005 annual report, I argued that active investment management by professionals – in aggregate – would over a period of years underperform the returns achieved by rank amateurs who simply sat still. I explained that the massive fees levied by a variety of “helpers” would leave their clients – again in aggregate – worse off than if the amateurs simply invested in an unmanaged low-cost index fund.”

He quotes some of the text from his bet:

“A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds.”

The nature of the specific bet was as follows:

“I publicly offered to wager $500,000 that no investment pro could select a set of at least five hedge funds – wildly-popular and high-fee investing vehicles – that would over an extended period match the performance of an unmanaged S&P-500 index fund charging only token fees. I suggested a ten-year bet and named a low-cost Vanguard S&P fund as my contender. I then sat back and waited expectantly for a parade of fund managers – who could include their own fund as one of the five – to come forth and defend their occupation. After all, these managers urged others to bet billions on their abilities. Why should they fear putting a little of their own money on the line?

“What followed was the sound of silence. Though there are thousands of professional investment managers who have amassed staggering fortunes by touting their stock-selecting prowess, only one man – Ted Seides [of Protégé Partners] – stepped up to my challenge.”

“For Protégé Partners’ side of our ten-year bet, Ted picked five funds-of-funds whose results were to be averaged and compared against my Vanguard S&P index fund. The five he selected had invested their money in more than 100 hedge funds, which meant that the overall performance of the funds-of-funds would not be distorted by the good or poor results of a single manager.”

The results so far?

Buffett is a long way ahead:

“the five funds-of-funds delivered, through 2016, an average of only 2.2%, compounded annually. That means $1 million invested in those funds would have gained $220,000. The index fund would meanwhile have gained $854,000 [with a compounded annual increase to date of 7.1%].”

“Fees never sleep”

Buffett is quite explicit about fees:

“I’m certain that in almost all cases the managers at both levels were honest and intelligent people. But the results for their investors were dismal – really dismal. And, alas, the huge fixed fees charged by all of the funds and funds-of-funds involved – fees that were totally unwarranted by performance – were such that their managers were showered with compensation over the nine years that have passed. As Gordon Gekko might have put it: “Fees never sleep.”

I estimate that over the nine-year period roughly 60% – gulp! – of all gains achieved by the five funds-of-funds were diverted to the two levels of managers. That was their misbegotten reward for accomplishing something far short of what their many hundreds of limited partners could have effortlessly – and with virtually no cost – achieved on their own.”

He’s quite explicit on this point:

“When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”

Will this type of underperformance continue?

In Buffett’s view, yes.

“In my opinion, the disappointing results for hedge-fund investors that this bet exposed are almost certain to recur in the future.”

He adds:

“Human behavior won’t change. Wealthy individuals, pension funds, endowments and the like will continue to feel they deserve something “extra” in investment advice. Those advisors who cleverly play to this expectation will get very rich.”

Some people can beat the market, even after fees. Picking them is the hard part.

Buffett explains that “There are, of course, some skilled individuals who are highly likely to out-perform the S&P over long stretches. In my lifetime, though, I’ve identified – early on – only ten or so professionals that I expected would accomplish this feat.

“There are no doubt many hundreds of people – perhaps thousands – whom I have never met and whose abilities would equal those of the people I’ve identified. The job, after all, is not impossible. The problem simply is that the great majority of managers who attempt to over-perform will fail. The probability is also very high that the person soliciting your funds will not be the exception who does well.

Why don’t wealthy people and institutions invest more in low-fee investments?

“I believe, however, that none of the mega-rich individuals, institutions or pension funds has followed [my advice to invest in a low-cost S&P 500 index fund] when I’ve given it to them. Instead, these investors politely thank me for my thoughts and depart to listen to the siren song of a high-fee manager or, in the case of many institutions, to seek out another breed of hyper-helper called a consultant.

“That professional, however, faces a problem. Can you imagine an investment consultant telling clients, year after year, to keep adding to an index fund replicating the S&P 500? That would be career suicide. Large fees flow to these hyper-helpers, however, if they recommend small managerial shifts every year or so. That advice is often delivered in esoteric gibberish that explains why fashionable investment “styles” or current economic trends make the shift appropriate.

“The wealthy are accustomed to feeling that it is their lot in life to get the best food, schooling, entertainment, housing, plastic surgery, sports ticket, you name it. Their money, they feel, should buy them something superior compared to what the masses receive.

“In many aspects of life, indeed, wealth does command top-grade products or services. For that reason, the financial “elites” – wealthy individuals, pension funds, college endowments and the like – have great trouble meekly signing up for a financial product or service that is available as well to people investing only a few thousand dollars. This reluctance of the rich normally prevails even though the product at issue is – on an expectancy basis – clearly the best choice.”

Trust me. Read the report yourself. It’s worth it.

(Sonnie Bailey is the author of this article and is an Authorised Financial Adviser (AFA). A disclosure statement is available free on demand: click here.)

Where are you on your journey to FI/RE?

One of my favourite podcasts is ChooseFI and over the weekend I listened to a cracking episode with with Joel of Financial 180.   The topic was the “Milestones of FI” and I thought it would be interesting to think about where each of us is on our journey.

Milestone 1:  Positive net worth

You hit your first milestone when your debts no longer outweigh your assets.  Some folks are fortunate and never start out with debt but, for most of us, we will normally start out with some debt e.g. a student loan.

Milestone 2:  $100K net worth

If you are a Personal Capital (financial tracking tool – US only so not much use for us) user then apparently when you hit $100K they start phoning you up to try and sell you their paid services.  It’s a somewhat arbitrary point but I think there is something deeply satisfying about hitting round numbers so I think it applies to us Kiwis as well.

Milestone 3:  F#$% U! money

F#$% U! money is classified as having about 2-3 years of expenses saved up.  Your amount will vary depending on your risk tolerance.  I’m reasonably risk averse so for me it would probably be at least 5 years!  It’s called “F#$% U” money as it enables you to walk away from a bad job if necessary.

Milestone 4:  Half FI

You need to know your “number” in order to know when you hit this mark.  You need to know how much you spend/want to spend and multiply that by 25 to get the standard FI amount.  Divide that by 2 and you have your half FI milestone number.

Milestone 5:  Lean FI

Lean FI is the amount you need to basically just survive with very little discretionary spending.  This is a bit extreme for me as I like some of life’s little luxuries but some folks are quite happy being relatively hardcore.

Milestone 6:  The crossover point

This is where you start to earn more from your investments than you are managing to earn from your salary.  You may feel that this makes you FI but realistically investment income can fluctuate so it is just a milestone.

Milestone 7:  Flex FI

Flex FI occurs when you are close enough that you are likely to be safe especially if you retain flexibility in your spending patterns or are willing to return to some form of work if your investment returns drop dramatically.  The value for this milestone is a net worth of 20x your annual spending.  I personally exclude my home from my net worth as it doesn’t generate an income but you may wish to include it if you are happy to sell up to support RE.

Milestone 8:  Financial Independence

You are technically financially independent when you hit a net worth of 25x your annual spending.  Any work you do now is by choice.  You could retire early and be reasonably sure you would not run out of money.

Milestone 9:  Fat FI

Fat FI is what you aim for if you are very risk averse or you want a retirement that has room for a large amount of luxuries.  The value for this milestone is a net worth of about 30x your annual spending.

The journey to FI can often seem long and boring.  Having a list of milestones that you can tick off seems like a good idea.  I’d strongly urge you to listen to ChooseFI and visit Financial 180.

Which milestone are you up to?

Top 3 Investment Options in New Zealand

(This is a repost from thesmartandlazy.com, originally published on 6 July 2017.)

I spent a lot of time on my blog talking about ETF and index fund investing in New Zealand. I believe they are great options and an import investment vehicle to help me achieve financial freedom.

However, there are three investment options are objectively better than ETF and Index fund with low entry requirement, low risk and high (sometimes guarantee) return. They are the low hanging fruit of personal finance that everyone should do it. Those three investments options are pay off consumer debt, join KiwiSaver and reduce the mortgage. I will go through each one of them and talk about they risk and return.

No.1 Pay off Consumer Debt

kill_bill_interior_a___repopo_by_repopo.jpg
You want to kill those consumer bills ASAP!

Credit card debt, car loan, payday loan, personal loan, hire purchase, P2P loan… All of those are consumer debt. Debts that are owed as a result of purchasing goods or services that are consumable and do not appreciate in value. Those debts usually have high-interest rate and exorbitant admin fee. If you are paying interest on depreciating assets, they are dragging back you financially. You won’t go forward if most of your income goes to those stupid bills. You need to get rid of them ASAP!

Screen Shot 2017-07-05 at 12.25.52 PM.png

Paying off debt is Investing

This concept may not be obvious to everyone but PAYING OFF DEBT IS INVESTING. For me, debt and investing are just two sides of the same coin. One side (investing) is to increase your wealth (with a given level of risk). Like you buy NZ Top 50 ETF from SmartShares, if the share price increase and they pay out a dividend, your wealth increased. On the other hand, the shares price may drop, and your wealth will decrease. So there is a risk of losing money with investing.

The other side of the coin (debt) will reduce your wealth. If you have $1000 credit card debt with 20% interest, your interest expense for the first month will $16.67. So your wealth reduced by -$16.67. Unlike investing, the debt will guarantee to reduce your wealth and drag you back financially. Therefore, reduce your debt will move you forward financially, guaranteed.

Whats the return and risk?

I will use a simplified sample to present the financial effect of paying off debt.

Assume you have $1000 in cash and $1000 credit card debt with 20% interest.  If you keep the $1000 in cash and don’t pay it off credit card debt, in one year, you will be $1000 x (1 + 20%) =  $1200 in debt. Financially you moved backwards by $200.

Now, you invest the $1000 cash in a 12 months term deposit with 3.25%. You still keep your $1000 credit card debt and not paying that off. In one year, your earn $1000 x 3.25% = $32.5 in interest from your term deposit. Take away $9.75 as tax; you will have $1022.75 in cash. On the other hand, your credit card debt still cost you $200 in interest. So financially, you moved backwards by $177.25.

Instead of invest that $1000 into a term deposit, you use that $1000 to pay off your credit card debt. Since the credit card debt is gone, it won’t occur interest. In one year, you will be in the same financial position.

Screen Shot 2017-07-05 at 3.23.13 PM.png

Look at all three scenarios, pay off credit card debt resulted in the best financial position. As you putting that $1000 cash to pay off your credit card debt, you are in fact getting 20% return on those $1000. Unlike other investment, those returns are Tax-free and guaranteed. If you need to get 20% after-tax return on investment, the pre-tax return will need to be 27.77%. That is an excellent return on investment. I am not saying you can’t get 27.77% return out there, but I am sure there is no investment (except KiwiSaver) can guarantee a 27.77% with no risk.

If we look that those high-interest-rate consumer debts, paying them off will be a great return for your money. Also, paying off consumer debt will reduce your financial risk and stress. You will be in a much better position when you negotiated mortgage term and resulted in better deals. That why paying off consumer debt is one of the top three investment options.

Screen Shot 2017-07-05 at 3.32.13 PM

What about Student Loan?

The student loan in New Zealand is interest-free as long as you are staying in the country. The payment only occurs when you have income. So you should just pay it off as you’ve got income. I would not be paying them off early unless you plan to leave the country for a long time.

Batman-Slapping-Robin.jpg

No. 2 – Join KiwiSaver

KiwiSaver is a voluntary, work-based savings initiative to help you with your long-term saving for retirement. It’s designed to be hassle-free, so it’s easy to maintain a regular savings pattern. Once you join KiwiSaver, at least 3% of your income will invest into a KiwiSaver fund. You can only access those fund until you use it to buy your first home or turn 65. What makes KiwiSaver to be a top investment option is because of employer contribution and member tax credit.

KiwiSaverlogo_6-3.jpg

Employer match

If you’re over 18 and is a member of KiwiSaver, when you make your KiwiSaver contribution, your employer also has to put money in. By law, the employer required to contribute at least 3% of your income. The employee can choose to contribute either 3%, 4% or 8% but employer only requires to match at 3%. Some employer may decide to match 4% or 8%.

It may seem you will be making 100% return on investment on your 3% contribution. However, IRD will take out tax from you employer contribution, so the actual return on your contribution is about 67%-89.5%. (You can find out why here)  It’s still an unbeatable risk-free guaranteed return.

Member Tax Credit

KiwiSaver Member Tax Credit is to help you save on your KiwiSaver. The government will make an annual contribution to your KiwiSaver fund (a.k.a Free money). The amount is $0.5 on every dollar up to $521.43. You will have to be 18 or above to receive the tax credit. This is a way of government help you save for your retirement and encourage you to join the plan. It cap at $521.43 so it will benefit for the most full-time employee but not favour mid to high-income earner.

55767664.jpg

 

Return on Employee

If you are over 18, fully employed, annual income at $55,000 before and contribute at 3%. Your minimum return on your contribution will be like this.

Your annual contribution (3%): $1650

Employer contribution after tax: $1361.25

KiwiSaver Member Tax Credit: $521.43

The return on your investment: (1650 + 1361.25 + 521.43 – 1650) / 1650 = 114%

Return on Self-Employed

If you are self-employed, you won’t get the employer match, but you are still entitled to member tax credit as long as you make a minimum manual contribution for $1042.86

Your manual contribution: $1042.86

KiwiSaver Member Tax Credit: $521.43

The return on your investment: (1042.86+ 521.43 – 1042.86)/ 1042.86 = 50%

Those are only your base return; you are likely to make investment return on your KiwiSaver Fund as well.  Here is a couples data on a KiwiSaver fund with different income level. The KiwiSaver fund cost and return data are based on SuperLife 80.

Screen Shot 2017-07-06 at 10.12.03 AM.png

Screen Shot 2017-07-06 at 10.18.50 AM.png

No. 3 – Reduce your Mortgage

Kiwisaver-can-be-your-deposit-500.jpg

Mortgage payment can easily be the biggest expenses on most homeowners’ budget. Average first home buyer will spend $1500/month on the mortgage, and it will cost more if you have a mortgage in a major city. Imagine what you can do with that money if you don’t have a mortgage payment.

Return on Reducing Mortgage

Paying off have the same effect on paying off consumer debt. It will give you a tax-free and guaranteed return. The return is not as high as those consumer debts because the interest rate on the mortgage is lower at 4% – 6%. The equivalent pre-tax return is around 8.3%.

Reduce your Mortgage or Invest elsewhere

Some people may think 7-8% is not a very good return, and you can achieve that with other investment options without taking a lot of risks, like the share market. However, I still think paying off the mortgage on your own home is a better option because you are paying off an asset that will provide you with a place to live, offset the cost of renting in the future and the house will increase in value (in the long term for most cases).

If you can’t decide to reduce mortgage or invest elsewhere, ask yourself a simple question: 

If you fully owned your house today, will you borrow $500k on your mortgage-free house to invest in share market? Or you will use your income to invest in the stock market every month?

If you say you won’t borrow on your mortgage-free home (like me), then you should focus on reducing that mortgage now. I basically asked the same questions but put it in a different perspective. If you have the money to reduce the mortgage, but you put it into the share market, you are basically borrowing on your house to share market.

Saving Big on interest expense

Since the mortgage size is usually over $200K (over $500k in Auckland) and the payment terms are 20-30 years. You end up paying A LOT on interest expenses. Check out the chart below.

Screen Shot 2017-07-06 at 11.25.13 AM.png

For a 30 years term mortgage at 5% interest rate, you will end up paying 93% extra for interest payment. So what will happen if we increase our payment and shorten the mortgage by ten years?

Screen Shot 2017-07-06 at 11.44.09 AM.png

When we shorten the mortgage term by ten years (-33%), our monthly payment increased by 23%, total interest paid decreased by 37.3%! Only 36.9% of your payment went to interest.

Reducing mortgage may not give you a high percentage return, but due to the size of the mortgage, the saving you are likely to make is in the hundreds of thousands. I will have a series of blog posts in the coming month to show you how to be smart on your mortgage with different setup and tips.

Conclusion

  • The top 3 investment options in New Zealand are paying off consumer debt, join KiwiSaver and reducing your mortgage.
  • Paying off consumer debt is investing. The returns are in the range of 15% – 35%. You will be in a better financial position once you pay off your debt.
  • A KiwiSaver member can enjoy instant return from minimum 50% – 110% due to member tax credit and employer match. However, that money is locked-in until you purchase your first home or turn 65.
  • Paying off return about 7% – 8% on your dollar, not as high compared to other. However, due to the size of the mortgage and interest paid, you are likely to be saving hundreds of thousand of the dollar

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

Sharesies (Beta) – How does it stack up to SuperLife and SmartShares on ETF Investing

(This is a repost from thesmartandlazy.com, originally published on 26 June 2017.)

Sharesies started rolling out their trial run (a.k.a beta) investments options a couple of weeks ago. I got their invitation recently and checked out their offering. Sharesies is currently offering six SmartShares ETFs for their investors including NZ Top 50, AUS Top 20, US 500, NZ Bond, NZ Property and AUS Resources. You can check out their current offers here.

Screen Shot 2017-06-27 at 9.04.08 PM

What is Sharesies

Sharesies is a New Zealand financial start-up company supported by Kiwibank Fintech Accelerator. They are an investment platform where users can make investments with small amounts of money. Their mission is to make investment fun, easy and affordable.

The main selling point of Sharesies is that by paying a $30 annual fee an investor can invest into multiple investments with the minimum at just $5. Also, there is a $20 credit for the early Beta investor.

Invest $5 into ETF

By comparison, SmartShares ETF’s initial investment is $500, set up cost is $30/ETF and monthly contribution minimum is $50. So Sharesies is a great way for beginner investors to invest a small amount into many low-cost, diversified ETFs. It bypasses the $500 initial investment and $30 set up fee with each ETFs.

On the other hand, SuperLife also offers the same ETF in their investment fund with a different management cost. You can check out the detailed comparison here.

While Superlife also doesn’t require initial investment and the minimum contribution can be just $1. How does Sharesies stack up to SuperLife and SmartShares on ETF investing?

Sharesies vs SuperLife & SmartShares

I’ve picked two popular ETF, NZ Top 50 and US 500, to run an analysis for 60 months (5 years). The analysis will compare the results on different contribution level(low and high contribution) for all three services. The low contribution will be at Sharesies minimum requirement, $30 initial investment (for the annual admin fee), $20/month contribution (about $5/week); The high contribution will be at SmartShares minimum requirement, $500 initial on each ETF, $50/month conditions.

NZ Top 50 ETF at low contribution

Here are the fee structures on the ETFs:

Screen Shot 2017-06-27 at 2.51.24 PM.png

This is the amount of low contribution and expected return:

Screen Shot 2017-06-27 at 2.53.41 PM.png

So Sharesies have a higher admin fee ($30) and ETF management cost (0.50%), so its expenses should be higher then Superlife NZ top 50 ETF. Since Sharesies are aiming for beginner investors, I put around $5/week as a low-level contribution. The $30 initial investment cost is to cover Sharesies annual fee. Smartshares will not be included in this analysis as the investment amount is too low.

Here is the investment return each year:

Screen Shot 2017-06-27 at 2.55.24 PM.png

Superlife did better as it has a lower management fee and admin fee resulting in a higher return for the customer. The 5-years different is $135.81, 8.4%.

NZ Top 50 ETF at high contribution

This is with a higher contribution and expected return:

Screen Shot 2017-06-27 at 3.05.08 PM.png

We increased the contribution to $50/month, put $500 as an initial investment and include SmartShares into the mix.

Here is the investment return each year:

Screen Shot 2017-06-27 at 3.06.46 PM.png

SmartShares came out on top despite the fact that they have a higher management cost. The main reason is that Smartshares don’t have an annual admin fee while Superlife charges $1/month. However, if you wish to cash out those Smartshares at this stage, it will cost you at least $30.

The difference between SmartShares and Sharesies is $163.34, 3.3%. Although both services have the same management cost, Sharesies charge $30/year admin fee which brings down the balance.

US 500 ETF at low contribution

Here is the fee structure on US 500 ETF:

Screen Shot 2017-06-27 at 3.10.52 PM.png

This is the amount of low contribution and expected return:

Screen Shot 2017-06-27 at 3.11.31 PM.png

This is more interesting as Sharesies have a lower management (0.31%) cost compared to Superlife (0.44%).

Here is the investment return each year:

Screen Shot 2017-06-27 at 3.13.12 PM.png

Due to the smaller holding, the lower management cost (0.35%) did not cover the higher annual fee ($30) with Sharesies. Superlife holding was $122.28 more than Sharesies in year 5, 8.1%.

US 500 ETF at high contribution

This is the amount of high contribution and expected return:

Screen Shot 2017-06-27 at 3.21.58 PM.png

Now we will do the same thing by increasing the investment to Smartshares minimum requirement.

Screen Shot 2017-06-27 at 3.27.48 PM.png

SmartShares USF came out on top with no annual fee and lower management cost. The different between SmartShares and Sharesies at year 5 is $154.75, 3.3%. The difference from Superlife is $41.5, 0.9%.

In both scenarios investors with a low contribution level are better with SuperLife. If you have $500 and $50/month to invest, SmartShares is the cheaper way. (Although I will suggest going with Superlife on NZ top 50. I’ve already covered that in another post)

How about portfolio building?

Since Sharesies investors can bypass SmartShares setup fee and initial investment requirement Sharesies is actually a great tool to build a simple portfolio. I will use US 500 ETF, NZ Top 50 ETF and NZ Bond ETF to build a portfolio.

Screen Shot 2017-06-27 at 9.24.17 PM.png

Here is a balanced portfolio you can easily build with Sharesies. 25% NZ Bond, 37.5% US 500 and 37.5% NZ Top 50. If we keep the low contribution at $20/month, you can put $5 in NZ Bond, $7.5 in US 500 and $7.5 in NZ Top 50.

If you wish to set up something similar in SmartShares, you will have to spend $30 x 3 =$90 on set up fees, at least $500 x 3 = $1500 initial investment and $50 x 3 = $150/month contribution. Not feasible at all.

SuperLife, on the other hand, as my best pick for portfolio builder in New Zealand can easily build the same portfolio. Let’s check out the cost difference:

Screen Shot 2017-06-27 at 9.54.24 PM.png

Here are the contributions and return:

Screen Shot 2017-06-27 at 9.55.27 PM.png

Here is the investment return each year:

Screen Shot 2017-06-27 at 10.28.32 PM.png

Superlife still edged out at year 5 with $123.15 more, 8.2%. I didn’t do a high contribution comparison here because SmartShares are really not for for portfolio building.

Conclusion

Based on the analysis, SuperLife is still the better choice on low contribution and most of the high contribution (except US 500 ETF) regarding cost. However, I still think Sharesies is doing something good here.

Sharesies is promoting to young Kiwis who never invested before by providing a straightforward and easy-to-use app. The sign-up process is simple and painless. The interface is robust and delightful. They’ve done an excellent job on explaining each investment options to beginner investment and make it accessible. Check out the screenshots below.

I don’t mind about the $30 admin fee if that what’s it take for a newbie to start investing for their future. I’ve been telling readers to spend $12/year on Superlife as they have a better user interface and functions over SmartShares. Sharesies interface and user experience are way better than both of them. They made investing as easy as shopping online, which should bring a lot of people into the world of investing.

Sharesies are still in beta, so there are some functions are missing, like reinvest and auto allocation. I am sure Sharesies will continue to improve on their functions and bring in more investment options. Hopefully more companies like Sharesies will pop up in New Zealand to bring more people into investing.

More investors, increase the market size, lower the cost!

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

SaveSave