Personal Finance

  • David Chaston probes how much realised capital gain is being made by landlords and by owner-occupiers, and how much windfall flows to them from their tax-free status

    By David Chaston

    There is a lot of talk about taxing capital gains "earned" by owning residential rental property.

    This article is an attempt to put an approximate value on those gains, and the amount of tax that may be available to a government.

    In the year to June 2017, there were 1,842,900 private dwellings in New Zealand. Of them, 1,160,500 were owner-occupied and 682,400 were rentals.

    Based on the 2013, 2006 and 2001 census data, and other Statistics NZ information, we are able to build an approximate estimate of how those dwelling numbers have grown since 2002, and how they have been distributed between owner-occupiers and renters, nationally, and for the main centres. (To be fair, some of this involves estimates based on other estimates, so there is likely to be inaccuracy involved. But the data is the best we can do with what is available.)

    We also know how many real estate sales transactions have happened over this period. And we know the median prices. This data is from the Real Estate Institute of New Zealand.

    In addition, from the same source, we have some unique lower quartile data available that can help us get a fix on the end of the market where you are more likely to find rented properties. That market is also where first home buyers start out, so it is not only investors in residential rental property operating there. (It is only very recently, from the Reserve Bank, that we have been getting insights into first home buyer activity. But none of that Reserve Bank data can yet be matched up reliably with the REINZ data).

    How much capital gain realised & how much tax avoided?

    Because we know this detail, we wondered if we could estimate how much capital gain has been realised in these transactions. And can we therefore get a rough estimate of how much income tax has been avoided by investors who hold rentals?

    Having built the relevant data, possibly we can.

    This is what it shows: In the year to June 2017, if the average holding time for the lower quartile sales was 10 years (some will be longer, some shorter), then the 10 year capital gain on those sales was about $1.8 billion. Of that, $1.2 billion of those gains were in Auckland, $200 million were in the Waikato, $100 million were in the Bay of Plenty, $125 million were in Wellington, and only $30 million were in Canterbury.

    That means that for lower quartile sales only, about $600 million of tax was avoided using this exemption for capital gains, of which a bit less than $400 million stemmed from realised transactions in Auckland.

    But the numbers are very much larger for owner-occupiers. For the same timeframe (the year to June 2017) owner-occupiers who sold realised $7.9 billion in gains, avoiding more than $2.6 billion in taxes (that would otherwise have applied if the gains were for anything else). In Auckland the gain was $4.8 billion (avoiding more than $1.5 billion in tax), in the Waikato, the gain was nearly $900 million ($300 million), Lesser amounts are involved in the Bay of Plenty, Wellington, and Canterbury.

    Taxing realised real estate gains could have given a 10% across the board income tax cut

    Just for perspective, personal income tax in the same period amounted to $29 billion. So the avoided tax for owner-occupiers of $2.6 billion, plus that for owners of rental property of $600 million, represents more than 10% of the income tax taken from individuals. Taxing realised real estate gains could have given a 10% across the board income tax cut.

    Or that $3.2 billion could have eliminated income tax for everyone who had annual taxable incomes of $30,000 and below, benefiting almost 1.5 million low income citizens.

    There were just 81,000 real estate transactions in that period. Our data shows that 5.3% of all owner-occupied housing sold in the year to June 2017, while only 2.9% of the stock of rented housing sold in the same year. Landlords are only half as likely to sell than owner-occupiers.

    A: Ten year capital gains from lower-quartile realised transactions

    In year to June NZL AKL WAI BOP WGN CBY
    NZ$ bln $ $ $ $ $ $
    2002 1.687 1.007 0.110 0.116 0.231 0.070
    2003 2.475 1.410 0.183 0.192 0.286 0.179
    2004 2.687 1.441 0.218 0.213 0.310 0.261
    2005 2.882 1.320 0.272 0.235 0.327 0.346
    2006 3.099 1.157 0.293 0.169 0.414 0.419
    2007 3.980 1.582 0.325 0.229 0.473 0.525
    2008 2.195 0.747 0.155 0.102 0.258 0.324
    2009 1.399 0.401 0.087 0.073 0.123 0.243
    2010 2.087 0.874 0.146 0.091 0.196 0.321
    2011 1.503 0.745 0.093 0.073 0.147 0.155
    2012 1.651 0.784 0.117 0.058 0.122 0.283
    2013 1.709 1.038 0.091 0.016 0.141 0.254
    2014 1.148 0.889 0.013 (0.029) 0.016 0.155
    2015 2.222 1.710 0.055 0.038 0.066 0.151
    2016 3.544 2.201 0.433 0.284 0.119 0.193
    2017 1.821 1.194 0.202 0.103 0.126 0.030
    NOTE: These are only estimates, based on lower quartile prices, actual sales volumes, and Census data for rented/owner splits. The numbers above may look 'accurate' but are derived by calculation and should be treated as a rough guide only.

    B: Ten year capital gains from owner-occupied realised transactions

    In year to June NZL AKL WAI BOP WGN CBY
    NZ$ bln $ $ $ $ $ $
    2002 7.802 4.453 0.572 0.526 1.175 0.365
    2003 11.461 6.134 0.812 0.860 1.469 0.795
    2004 13.401 6.364 1.078 1.114 1.586 1.156
    2005 14.008 5.677 1.266 1.142 1.587 1.419
    2006 13.845 4.649 1.297 0.823 1.815 1.558
    2007 17.062 6.978 1.357 1.073 1.995 1.946
    2008 9.322 3.381 0.678 0.473 1.047 1.257
    2009 5.587 1.986 0.395 0.325 0.441 0.976
    2010 8.938 4.055 0.633 0.385 0.798 1.314
    2011 6.734 3.312 0.387 0.349 0.597 0.587
    2012 6.925 3.701 0.438 0.227 0.434 1.115
    2013 7.591 5.140 0.352 0.009 0.466 0.950
    2014 4.892 4.172 (0.048) (0.283) (0.100) 0.707
    2015 9.895 7.767 0.151 0.092 0.296 0.690
    2016 16.157 9.783 1.908 1.410 0.688 0.900
    2017 7.893 4.839 0.890 0.598 0.583 0.265
    NOTE: These are only estimates, based on median prices, actual sales volumes, and Census data for rented/owner splits. The numbers above may look 'accurate' but are derived by calculation and should be treated as a rough guide only.

    Interestingly, the transactions to June 2017 now encompass a period where the dollar value of the gains being recorded are falling. Not only are prices past their peak, but transaction volumes are declining too.

    If these real estate gains were taxed in this way in the year to June 2016 when both the volumes were much higher and the ten year value gains were also higher, the amounts of tax avoided is much, much higher. In the lower quartile market, the gains were double the 2017 levels. In the owner-occupied market the level was similarly doubly higher. The tax avoided was probably in the order of $6.5 billion.

    The nature of the real estate cycles means that any tax on these realised capital gains will be volatile, and therefore may not be suitable as a substitute for regular income tax adjustment. A doubling (or halving) of these tax flows will be very messy for Government budgeting. But they might help in other ways, like paying down Government debt, making some big one-off capital expenditures, or bolstering the NZ Super Fund.

    Just a profit like any other

    Those choices are however not on the table so long as we regard gains from housing values as something 'special'. They aren't. They are just a profit like any other and should be taxed like any other profit. All gains should be treated equally in my view; the income/capital distinction is arbitrary and hardly justifiable. (On the other hand, I do think the realised/unrealised distinction is relevant. We should not be taxing theoretical paper gains of any sort. But those who favour an assets tax might disagree).

    As for a homeowner exemption, other than a sop to voter greed, I can't see the justification for that either.

    Treat all gains (and losses) equally in tax law.

    (Tax law also makes a distinction between "earned" and "unearned" income. Capital gains are certainly "unearned" having basically just fallen out of the sky. But this is another distinction that is pretty artificial and seems hard to justify).

  • Generation Rent Investment Guide episode 4: What to look out for when managed fund shopping

    By Jenée Tibshraeny

    How can you be confident about investing in financial markets when there are so many forces at play that can make or break your investment?

    US President Donald Trump could push North Korea over the edge, interest rates could stay low for longer, world leaders could adopt more ambitious carbon emissions targets, China could up the ante on its capital controls, or Winston Peters could become Deputy Prime Minister.

    No one knows what the future holds.

    The question is, who’s in the best position to protect your money from the risks and see where the rewards lie?

    There’s a school of thought that navigating the minefield that is the market is humanly impossible, so over the long term you’re best investing in funds that tracks the market. I looked at how you could do so through passively managed or exchange traded funds in this piece.  

    There’s another school of thought that you’re best paying higher fees for a fund manager to keep re-jigging your investment to beat the market. I consider this option in this instalment of my Generation Rent Investment Guide.

    The basics

    If you’re a KiwiSaver member, you’re probably already investing in a managed fund, where your money is pooled with other investors’ and spread across different kinds of investments.

    The beauty of this is that you get access to assets and products you wouldn’t always be able to invest in on your own. Your risk is also reduced by your investment being spread across a range of these.

    While you decide what sort of fund you would like to invest in based on your risk appetite, you’re pretty much leaving it to the experts to do the work.

    An Authorised Financial Adviser (AFA) at Hassan & Associates, Simon Hassan, says: “While the research shows that few active managers outperform passive funds over the long term, capable active managers can add value, especially by reducing risk.

    “If this makes investors feel a bit more comfortable during or after a downturn that can be worth a lot.

    “Good active managers may use derivatives to hedge currencies, or to limit 'downside risk' - seeking to lessen the impact of a market downturn. Others try to add value by researching little known (say smaller, or emerging) companies.”

    Hassan suggests investing in a mix of actively and passively managed funds.

    Nonetheless, if we’re just looking at the active side of things, these are some of the questions you should be asking as you weigh up your options:

    - What am I trying to achieve?

    Before you do anything, you have to identify your risk appetite and decide what sort of asset class you would like your fund to be based on.

    There’s a quiz, as well as other basic investment information, at, which will help steer you in the right direction.

    Conservative funds are more weighted towards bonds and cash than growth funds, whereas growth funds are more weighted towards equities and property.

    - How active are ‘active’ fund managers?

    Once you have a clear idea of your risk and the time you have to maximise returns, AFA and Summer KiwiSaver investment committee chair, Martin Hawes, suggests you check how actively managed a fund really is.

    You should ask yourself whether the higher fees you’re being charged are for true active management, or whether the fund is actually just a closet index-tracker.

    Melville Jessup Weaver actuaries Ben Trollip and William Nelson consider the issue: “If I [a fund manager] were to hold 48 of the 50 stocks in the S&P/NZX 50 index (at their index weights), and just slightly overweight Xero and underweight Trade Me, would you be happy paying me a large fee?

    “With over 90% of my portfolio simply replicating the index, perhaps you’d argue I’m due at most 1/10th of a full active management fee.

    “After all, most of my portfolio would generate the index return, making it unlikely that the overall result would differ too much from the benchmark.”

    They go on to explain: “One way to quantify activeness is “active share”. Active share measures the level of activeness by tallying up how different a portfolio is to the benchmark.” (See their paper for a longer explanation).

    The six New Zealand equity managers Trollip and Nelson looked at in December last year, have active shares of between 27% and 53%.

    “This is perhaps surprising for a cohort of “active” managers,” they say.

    "Managers C and E have just a net 27% of their portfolios different to the index – or, put another way, they are 73% passive! These managers are relying on just a net 27% of their portfolios to reach their value added target.”

    Although Trollip and Nelson have looked at a small sample, the funds with more active share generally perform better.

    Yet Trollip and Nelson recognise it’s difficult for New Zealand fund managers to differentiate from the index as much as their counterparts overseas, as our market is very concentrated.

    So while you should make sure you are getting what you pay for, they say you should be sure of your risk tolerance “before blindly pursuing high active share portfolios”.

    Hawes recognises it is difficult for retail investors to calculate active share, but says you can look at the top 10 or 20 holdings in the portfolio and see how closely they align to the index.

    - By how much can fund managers adjust their asset allocations?

    The other thing to look at is how much flexibility fund managers have to adjust their asset allocations to best manage risk as market conditions change.

    This information should be in a fund manager’s statement of investment policy or product disclosure statement.

    As you can see in this example, ANZ’s Growth fund managers have quite a bit of flexibility in the way they allocate funds.

    Hassan says it’s also important fund managers have a “disciplined approach”, with “clearly defined asset selection, portfolio construction and management processes” that don’t veer from one idea to the next, and stay 'true to label'.”

    In other words, you don’t want to find out that a ‘NZ share fund’ actually includes a lot of fixed interest, or derivatives for example.  

    Hawes goes on to say that while it’s one thing for fund managers have the mandate to allocate assets tactically, it’s another thing whether or not they actually do so.

    How are you and I supposed to find out the extent to which they’ve done so as market conditions have changed? Simply ask?

    It’s not that simple according to Hawes: “One of the really difficult things [in] this whole thing regarding funds is that the retail investor, without independent research, will find this really hard to do. Like really hard.

    “Financial advisers… spend pretty much all their working hours looking at this stuff. But a retail investor, even if they knew what they were looking at, they probably wouldn’t have the time…

    “Morningstar and the likes are making visits to the fund managers and saying: ‘What are your processes and who are your people?’ which are the two key things.

    “Whereas if you rang a fund manager and said, ‘I’d just like to come in and have a really good chat because I’m thinking about investing $10,000', they’d stifle their laugh, only because they’re being polite.”


    - How have fund managers weathered past storms?

    While these structural considerations are paramount, there’s no getting around the fact you’re going to look at what a fund’s past returns are.

    Hassan warns this is a “folly”, as just because a fund has performed well in the past, doesn’t mean to say it will do so in the future.

    I agree, but believe there’s value in taking a long term view of a fund’s performance.

    Sure its returns may have been good over the last couple of years while the market’s been a box of butterflies, but how did it perform relative to the market during the 2008 Global Financial Crisis?

    - Exactly what are you paying fund managers for?

    Paying higher fees (of around 4% for example) is part of the managed fund package. However you need to weigh up whether you’re getting bang for your buck, in terms of returns and active management.

    Furthermore, Hawes is morally against fund managers charging performance fees.

    He says it’s a “one-sided deal” for them to receive a fee for beating the market, but not lose out if they don’t beat the market.

    Yet with boutique fund managers typically the ones charging performance fees, Hawes admits many that slap on these fees are actually very well performing.  

    He still calls performance fees “a nonsense” as they incentivise fund managers to chase returns, not manage risk.

    - Who are the individuals you’re entrusting your money with?

    Equally as important as the process being followed to invest your money, Hawes suggests you pay attention to the people doing the job.

    Ultimately he says: “People invest with people.”

    Have a look at how a fund manager has dealt with market peaks and troughs in the past.

    Albeit from a biased position, Hawes says it can be beneficial investing in a fund where there are “people with a profile” involved.

    “I’m thinking of myself here as well, with my involvement with Summer KiwiSaver. It’s a completely different beast when your name is over the door… [You’re] basically putting your reputation on the line.”

    Of course, you don’t simply want to invest in a fund due to it having high profile managers, but reputation and accountability are worth considering.

    This is all too hard…

    If you’re anything like me, at this point you’re thinking, how am I meant to weigh up all these factors and make a well informed investment decision?

    Retail investors are on the back foot when it comes to getting access to information and it seems that unless you have hundreds of thousands of dollars to invest, it’s going to be difficult to get help. Even Hassan says his average client has around a half a million dollars invested.

    Don’t despair.

    Hassan reassures me there are still AFAs who will advise you. You just need to make sure the advice is independent. It’s better for you to pay your adviser’s salary than the firms whose products they’re providing “advice” on doing so.

    If you think you’ve got this under control yourself, I suggest you ask fund managers as many questions as you need to ensure you’re confident in your investment decision.

    With the proliferation of KiwiSaver, and a generation of younger people looking to the equity rather than property market, I believe fund managers would be foolish to be dismissive of prospective clients - no matter the size of their wallets.

    Take it from the journalist - do your homework, ask, and don’t settle for convoluted responses that mask the facts.

  • NZ First's Winston Peters eyes minimum wage increase to $20 an hour from $15.75 over three years

    With recent opinion polls suggesting Winston Peters will be king or queen maker after the September 23 election, the NZ First leader has announced that his party wants to increase the minimum wage to $20 an hour.

    This would be done over three years, Peters said in a speech in Tauranga, and NZ First would also introduce a tax package for employers and businesses to negate their increased costs.

    Interestingly Peters' speech refers to his party's confidence and supply agreement with the last Labour government between 2005 and 2008 that saw the minimum wage increased by $3 an hour.

    "We insisted that the minimum wage go from $9 per hour to $12 progressively by 2008. That is the biggest rise ever in the shortest time ever in this country’s history," Peters said.

    Does this suggest that Peters may be leaning towards backing a Labour Party reinvigorated under new leader Jacinda Ardern? On the surface his minimum wage policy may sound more palatable to Labour than National. But Peters will no doubt keep us guessing up to, and probably beyond September 23.

    The minimum wage is currently $15.75 an hour. In June then-Labour leader Andrew Little said Labour wanted to increase it to $16.50 an hour. The Greens want to increase it to $17.75 next year.

    The minimum wage was increased by 50 cents to $15.75 an hour from April 1. Announcing this in January, Workplace Relations and Safety Minister Michael Woodhouse said the increase would benefit about 119,500 workers and increase wages by $65 million a year. Woodhouse also pointed out there had been annual increases to the minimum wage since 2009.

    Here's more from Peters' speech below.

    Increasing minimum wage

    New Zealand First will build our economy from the bottom up, creating opportunities for New Zealanders, boosting our economy and increasing productivity.

    Our goal is to increase the minimum wage to $20 over three years. Drastically increasing the minimum wage will increase productivity and stimulate the economy.

    New Zealand First’s record on fair wages in this country is a proud one. In 2005 we campaigned to address the then low minimum wage under the Labour government.

    As part of our confidence and supply agreement with Labour in 2005 following the election we insisted that the minimum wage go from $9 per hour to $12 progressively by 2008. That is the biggest rise ever in the shortest time ever in this country’s history.

    We know that without a change in tax for Employers and Businesses that can’t happen.

    Employers - Business tax package

    Accordingly, we will: - introduce a tax package for New Zealand Employers and Businesses to negate the increased cost to employers and businesses of paying fair wages.

    Removing GST on basic food

    New Zealand First will lower the family food bill by removing GST on basic essential food. By lowering the cost of the household food basket we will bring much needed relief to thousands of low income New Zealanders.

    GST would come off all basic food items – not restaurant and takeaway meals. This is a bold policy which goes to the heart of inequality that is undermining our society.

    There are estimated to be 212,000 children in poverty in New Zealand. In April this year the Salvation Army said 20 per cent of New Zealand children were living in a household that regularly goes without essentials such as adequate food, clothing or heating. That’s one in every five children in New Zealand.

    The cost of removing GST on basic essential food is somewhere  between $600 million and $700 million. And for those armchair critics who have long forgotten, or have never known “struggle street”, who don’t know what basic or essential food is - I recommend they ask their grandmother.

    Clampdown on Tax Evasion Behind closed doors the National government has been heavied by giant multinational bully boys over a proposed tax clampdown and our government buckled like wimps. Multinationals are evading paying tax in New Zealand of between $7 billion to $10 billion a year. It’s a rort.

    They’re getting away with it and the government is letting them. A shady outfit from the United States no-one has heard of, the Digital Economy Group, pressured the New Zealand government and won. The so-called crusher Revenue Minister Judith Collins was crushed. Finance Minister Steven Joyce, huddled behind his desk and waved a white flag.

    The giant multi-nationals want to paralyse the OECD. They’re now doing the same to the National government. And they’re succeeding.

    Given the Labour Party’s already announced policy on taxing multinational corporations to raise $200 million, it seems that like the National government they have already caved in even without having discussions with the secretive international group. New Zealand First would clamp down on these giants who cheat us.

    We are going to clamp down on tax evasion. Multination corporations will be required to pay fair tax in New Zealand. For example Tegel, with its $614 million turnover pays only .38 percent of tax (profit was $34.2 million). This will end under New Zealand First.

  • We review how much New Zealand households have in financial assets, the components, and how they are growing (or not). The levels may surprise you

    New Zealand households have a huge portfolio of assets on their balance sheets - far more than most of us realise.

    Most conversation around the household balance sheet revolves around liabilities, and mainly those for housing.

    But you are likely to be surprised by the scale of the assets.

    No-one is suggesting this wealth is evenly distributed, but conversation about wealth distribution should start by understanding this data.

    Household assets are growing modestly - over the past ten years they have grown on average +4.0% pa. This is entirely credible because if you remove inflation, that basically mirrors GDP growth over the period.

    But the key thing is, apart from the Global Financial Crisis, that growth has been steady and compounding.

    Over the past 10 years, these assets have risen from $545 billion to $806 billion, almost a 50% rise.

    These are the components of these assets, according to the excellent analysis by the Reserve Bank. It is very comprehensive and is missing just one element that we can think of; what households have invested into mortgage trusts and property syndicates. (And we also don't know how much is 'loaned' by loan sharks and held as loans in the black economy).

    NZ$ bln, as at March, Note 2007 2012 2017 avg pa
    only as held by households ...   $ $ $ %
    Notes & Coin C22 1.9 2.5 3.3 +5.8
    Deposits at banks S40 67.9 101.9 157.8 +8.8
    Deposits at non-bank deposit takers T4 12.1 4.9 3.4 -11.8
    Kiwibonds, other Govt bonds D30 0.6 0.7 0.5 -1.7
    Local Govt securities C22 0.3 0.4 0.3 +2.4
    Corporate bonds C22 2.9 4.4 3.9 +3.1
    Loans via lawyers/contributory mortgages C22 0.8 0.5 0.3 -9.8
    NZ listed shares C22 109.3 76.3 120.4 +1.0
    Unlisted shares C22 59.3 91.6 117.9 +7.1
    Equity in unincorporated businesses C22 196.8 228.0 246.9 +2.3
    Overseas listed shares C22 7.8 6.3 7.8 +0.1
    Managed Funds C22 42.2 37.6 45.4 +0.7
    Cash management trusts T46     7.9  
    Mortgage trusts/property syndicates   ?? ?? ??  
    Equity in life insurance policies T42 10.5 8.1 8.7 -0.2
    KiwiSaver T43   12.5 41.0  
    GSF / NPF / other Superannuation T44 31.9 31.7 35.4 +1.0
    Non-life insurance claims C22 0.8 9.9 5.3 +20.8
    Peer-to-peer       0.1  
    Loan shark / black economy assets   ?? ?? ??  

      ===== ===== ===== -----
    Total household financial assets C21 $ 545.0 $ 617.3 $ 806.4 +4.0

    The overall growth may be just +4.0% pa, but that masks some other significant changes which are shown above. Specifically, bank deposits are up +8.8% pa, and the collapse of the finance company industry can also be seen in the above table.

    Also the growth in equity in the businesses of sole traders and other unincorporated enterprises has been very sub-par.

    However that low growth hasn't shaken the dominance of these sorts of enterprises - it's just that they are not really growing. And neither are the holdings of households in listed shares.

    This huge asset base is not being propped up by debt. Leaving housing debt to one side for the moment (because housing assets are not included in this analysis either), this $806.4 bln of household assets comes with just $30.5 bln of financial liabilities.

    That $30.5 bln of liabilities are made up of $15.3 bln in consumer debt (of which $6.8 bln is for credit cards), plus $15.2 bln in student loans. (And consistent with having no coverage on the asset side, we just don't know the level of what is owed in the black economy, including to loan sharks.)

    If you have read this far, you are likely to be wanting to know what the assets and liabilities are for households related to housing.

    Here is that data: (the blue line is the asset value, the orange line is the liabilities owed by households to both banks, and to other housing lenders).

    Adding the two components (housing and non housing assets), total household assets in New Zealand are an amazing $1.8 trillion. Who knew? Household liabilities total $264.5 bln or only 15% of the asset values.

    That is the size of the pie. Now we are ready to talk about the distribution of this wealth.

  • Terry Baucher questions whether the Government's adoption of the OECD inspired BEPS initiative will be undermined by a lack of IRD staff to enforce it

    By Terry Baucher*

    This election campaign certainly has a fresh approach because it’s the first time I can recall both Labour and National boasting about how much tax they’ll raise. Barely three weeks ago Labour announced measures which it expected would raise an additional $300 million per year from multinationals.

    Labour’s proposals include following the example of Australia and the United Kingdom and introducing a “Diverted Profits Tax”. 

    Not to be outdone, the Government dumped over a thousand pages of commentary and analysis a week ago as part of its announcement of the response to the OECD’s Base Erosion and Profit Shifting (BEPS) initiative. These measures are expected to raise $200 million per year. 

    However, there’s a risk that regardless of which party is in power after the General Election, Inland Revenue’s Business Transformation proposals may reduce its capacity to enforce the law and put those tax revenues at risk. 

    The Government’s BEPS proposals counter several key multinational taxation areas. Firstly, the practice of foreign parents charging their New Zealand subsidiaries high interest rates to reduce their taxable profits in New Zealand. 

    Secondly the use of artificial arrangements to avoid having a taxable presence in New Zealand. Measures will also ensure multinationals are taxed in accordance with the economic substance of their activities in New Zealand. 

    Finally, countering strategies that multinationals have used to exploit gaps and mismatches in different countries’ domestic tax rules to avoid paying tax anywhere in the world. In a surprise move the “hybrid mismatch arrangements” targeted include foreign trusts. In addition, Inland Revenue will get additional powers to investigate “uncooperative” multinational companies. This includes extending the “time bar” period during which Inland Revenue may investigate prior years from four to seven. (It’s not clear whether that would apply retrospectively). 

    There’s no plan to introduce a diverted profits tax and overall the proposals are expected to raise about $200 million annually when they are fully implemented from 1 April 2019. The Government is so confident about the success of these measures that it had already included some $250 million in its forecasted tax revenue over the next three years. 

    But whether it’s $200 million or $300 million annually it’s not terribly significant in the context of a projected $12.5 billion corporate income tax take for the year to 30 June 2018. Multinationals do not appear to be the “magic money tree” of popular imagination. The hundreds of pages of supporting documents released last Friday contained some interesting snippets about the scale of multinational activity in New Zealand and what Inland Revenue knows about multinationals’ tax planning. For example, the regulatory impact statement on the transfer pricing and permanent establishment avoidance proposals noted: 

    “There is limited certainty of evidence in relation to the problem of transfer pricing and PE avoidance arrangements. This is because such activities are often not directly observable in the absence of specific audit activity. However, Inland Revenue is aware of about 16 cases involved in these types of BEPS arrangements which are currently under audit that collectively involve about $100 million per year of disputed tax. While there are only 20 New Zealand-owned multinationals that earn over the threshold for some of the main proposals (over EUR €750 million of consolidated global revenue), the European Union (EU) has estimated that there may be up to 6,000 multinationals globally that do. However, we do not know how many of these global multinationals operate in New Zealand.” 

    Simply gruesome

    Before she entered politics Minister of Revenue Judith Collins was a tax partner with Simpson Grierson, or “Simply Gruesome” to its rivals. And “simply gruesome” is probably what most of the foreign trust industry is feeling after seeing the proposals for countering hybrid mismatch arrangements. 

    The obtuse-sounding hybrids mismatch proposals tackle structures often involving “hybrids” such as limited partnerships or other special entities That exploit mismatched tax treatments between countries of financial instruments and entities. As a result of these mismatches the overall tax payable by a group of companies is reduced. Addressing these types of arrangements is a key part of the BEPS initiative internationally. 

    Inland Revenue has decided foreign trusts represent a form of hybrid mismatch arrangement (a rather questionable argument which unsurprisingly the foreign trust industry rejects). Accordingly, it proposes to tax any income earned by a foreign trust to the extent it is not taxable in another jurisdiction. This would mean the end of the current exemption from non-New Zealand sourced income for foreign trusts. 

    What concerns foreign trust advisors is the possible application of the financial arrangement and foreign investment fund regimes to the investment portfolios of foreign trusts. These regimes are fairly unique and their application could actually be a case of imposing a tax charge where none currently exists. (This is primarily because often the overseas tax involved is capital gains tax which usually only arises on disposal). A further drop in the numbers of foreign trusts registered therefore seems likely particularly if the financial arrangement and foreign investment fund regimes are applied to foreign trusts’ investment portfolios. 

    However, there is a huge “but” to these proposals and it’s a big one: will Inland Revenue actually have sufficient staff with the proper skills to enforce the new rules and identify new risk areas?

    Would you do the same job for $20,000 less?

    In the past month, Inland Revenue has revealed more about how its new computer system START (simplified tax and revenue technology) and Business Transformation programme will affect Inland Revenue itself. It believes it will be able to reduce its staff by about 1,500 or 30% of its current workforce over the next four years. That’s a big call and arguably a bigger risk than the projected $1.5 billion cost of START over ten years. Anyone who has been hanging on the telephone trying to talk to someone at Inland Revenue will probably have a sceptical view about the proposed staff cuts.

    That said, there’s no doubt START will bring improved efficiencies. For example, an August 2012 report on Business Transformation noted that approximately half of Inland Revenue’s 1,100 data entry processing staff were engaged full-time on correcting data entries. 

    The problem is that the proposed staff cuts appear to go well beyond redundant data entry processing staff. Leaked documents show changes at all levels including the specialised investigators, analysts and legal advisors – key personnel in addressing complex tax issues and countering aggressive tax planning. 86 managers are to reapply for 55 new posts, and 632 investigators are to be “reassigned” with senior investigators facing a proposed $20,000 cut in their salary bands. Would you do the same job for $20,000 less? It’s small wonder rumours are circulating that the proposals have badly hit staff morale at Inland Revenue.

    The proposed loss of investigation staff is frankly perplexing. At present according to Inland Revenue’s 2016 Annual Report each dollar spent on investigation yielded $7.91 against the target of $7:$1 

    This return on investment is a strong case for increasing funding to investigators which in fact is one of Labour’s proposals. It has said it would give Inland Revenue a further $30 million for investigation work. 

    As noted above, Inland Revenue is at present not always aware of all the tax planning schemes in operation. It seems scarcely credible that Inland Revenue is proposing to make drastic changes to the staffing and salaries of the very people needed to counter those arrangements. 

    The question therefore arises: will the BEPS proposals be undermined by lack of staff to enforce them? Only time will tell.

    *Terry Baucher is an Auckland-based tax specialist and head of Baucher Consulting. You can contact him here »

  • Looking starkly at Generation Rent, parties are proposing policies which would protect those who will never own a home

    Even with the most aggressive policies deployed against New Zealand’s housing crunch, the inaccessibility of affordable housing is likely going to persist for long enough that thousands will be locked out of home ownership for the rest of their lives.

    This cohort – dubbed ‘generation rent’ – is a voting bloc to be reckoned with, and will need protection from the uncertainty brought by perpetual renting.

    Some of New Zealand’s political parties have picked up on this, and have come up with policies to combat it.

    The Opportunities Party has launched a policy that would reform the Residential Tenancies Act to strengthen the rights – and staying power – of renters.

    Gareth Morgan’s proposals follow the example of Germany, where less than half the population own their home, but citizens can be assured of residential stability due to strong legal protections afforded them by the government. The key, he says, is long-term tenancy rights. "German law provides for a greater security of tenure: tenants can give 90 days' notice, otherwise the tenancy is ongoing unless the landlord is able to give a serious and legitimate reason for termination."

    TOP would see this model followed in New Zealand. Per its website: “Under this model the default standard lease makes it far easier for a tenant to remain in the premises long term. This will be achieved by restricting the conditions under which a landlord can evict a tenant to those of non-payment of rent or property damage. Sale of a property is not necessarily a legitimate reason for eviction.”

    This change to tenancy law would come alongside TOP’s flagship proposal to tax imputed rental, including on residential property, which would see some speculative investment channelled away from housing into more productive avenues.

    The benefits, he says, are much needed in a climate where more and more families will be exposed to the vicissitudes of the rental market. Crucially, this is not a protection from un-insulated, mouldy, leaky houses; it is a protection from being evicted from them.  

    The proposal echoes Metiria Turei’s 2016 Residential Tenancies (Safe and Secure Rentals) Amendment Bill, which was voted down in Parliament after its first reading in 2016.

    The bill would have removed the obligation on tenants to pay leasing fees, set a default three-year fixed term for residential tenancies, limited rent increases to no more than once a year, required that the formula for calculating any future rent increase be included in tenancy agreement forms, allowed tenants the right of renewal on rental agreements, and restored the 90-day notice period for when landlords wished to sell the property.

    The last proposal in particular can be contrasted with the German one, and that of The Opportunities Party. TOP would take tenant protection even further, meaning that selling a property would not be a sufficient reason to evict tenants living in it.

    Other parties have taken aim at the quality of rental housing itself.

    Labour’s tenant protection policy comes in the form of Andrew Little’s Healthy Homes Guarantee Bill, which is currently making its way through Parliament. The Bill would “set standards that will require all rental properties to meet proper standards in: insulation, heating, ventilation, draught stopping, and drainage.” As the poor quality of much of New Zealand’s rental housing stock, and its link with respiratory illness, has been a significant issue in the last few elections, this is a safe, though cautious, move.

    Tax deductibility

    The New Zealand First housing policy, which as of writing has not been updated since 2014, would make home improvements tax deductible, giving landlords an incentive to make upgrades to their rental properties. Under NZ First's policy, specified improvements could be expensed for income tax purposes in the year they were incurred. Insulation, solar heating, heat pumps, wood pellet burners, disaster protection and earthquake strengthening one's rental property would all be income tax deductible.

    The NZ First approach to insulating houses would not be to mandate that owners insulate their rental properties through legislation, as the National government has or Andrew Little’s Healthy Homes Bill would do. Nor would it directly subsidise them, as Labour plans to do with the revenue gained from closing negative gearing loopholes, or as the government has with Warm Up New Zealand. Instead, it would provide a tax incentive for owners of rental properties to make their properties liveable.

    And from the right? 

    Until the Maori party releases their policy manifesto, we can only guess at what protections they would afford to the coming generation of perpetual renters. The ACT Party would not dare propose a government protection for anyone poor enough to be renting their home.

    National’s refusal to acknowledge the extent of the housing crisis will likely stop them from doing anything like TOP and the Greens are proposing, in giving tenants more rights against their landlords.

    National legislation

    Regarding healthy homes, however, the National government last year passed legislation amending the Residential Tenancies Act, which required owners to install smoke alarms and modern insulation in rental properties, and enabled the Ministry of Business, Innovation and Employment to enforce these standards against landlords.

    The insulation requirements applied to social housing as of 2016, but will only kick in for other rentals from 1 July 2019. Per National, “Landlords must include in all tenancy agreements from 1 July 2016 a declaration of the level of insulation underfloor, in walls and in the ceiling, and all insulation installed from 1 July 2016 must be to the latest 2008 standards.”

    This seems to make Andrew Little’s Bill redundant, and National has of course criticised the bill, arguing that it would actually delay the implementation of upgrades already mandated in the 2016 changes. Little’s bill would require compliance within five years of royal assent; National’s bill will require all landlords comply with insulation standards by 2019.

    Regardless of whether this criticism holds weight (Little’s Bill has passed its first two readings and looks likely to be passed by the end of the year), the two major parties have kept to very similar ground in terms of protecting tenants. With progressive tenancy protection proposals coming from Gareth Morgan and Metiria Turei, two of the most different characters in 2017’s political landscape, it is interesting to see whether their proposals will catch on as more of the electorate becomes part of generation rent.

  • Consumer credit contract providers celebrate successfully lobbying the Government to exempt them from new financial advice regulation 

    Consumer lenders are breathing a sigh of relief the Government has heeded their calls and excused some of them from new legislation set to replace the Financial Advisers Act.

    Commerce and Consumer Affairs Minister Jacqui Dean has included a clause in the Financial Services Legislation Amendment Bill, exempting consumer credit contract providers that already fall under the Credit Contracts and Consumer Finance Act (CCCFA), from the legislation.

    The Bill, which was introduced to Parliament on August 3, says: “The exclusions from being regulated financial advice include advice given… by a lender under a consumer credit contract or insurance contract for the purpose of complying with the lender’s responsibilities under section 9C(3)(a) to (e) of the Credit Contracts and Consumer Finance Act 2003 (this is a new exclusion, not one carried over from the Financial Advisers Act 2008).”

    This means the likes of SBS Bank's Finance Now, Toyota Finance, Instant Finance and The Warehouse Financial Services Group (which is being bought by Finance Now), won’t have to deal with new licencing and disclosure requirements outlined in the Bill.

    It also means they won’t have to report to the Financial Markets Authority (FMA), in addition to the Commerce Commission, which oversees the CCCFA.

    Consumer lenders, which act as brokers, are however still covered by the Financial Services Legislation Amendment Bill.

    The Bill aims to improve New Zealanders’ access to advice and even the regulatory playing field for advisers.

    The Financial Services Federation Executive Director Lyn McMorran dubs the consumer lender exemption “common sense”.

    She says all the necessary consumer protections already exist under the CCCFA, so the exemption avoids a doubling up of red tape and regulation.

    The CCCFA stipulates how credit contract providers have to give their customers advice around the suitability of their products, whether or not they can actually afford them, and whether or not they’re making an informed decision and understand what they’re getting in to.

    McMorran also points out new lender responsibility principles were introduced under the CCCFA in 2015.

    While most of her organisation’s 50+ members will be benefit from the exemption, she is pleased brokers remain covered by the Bill, as “the broker relationship is different”.

    “They do have an adviser relationship, because they’re actually looking at a whole range of providers’ products and saying, ‘this is the best one for you’. That has to be guided by the principle that it’s in the customer’s best interest and not because it pays the highest commission.”

  • Augusta is syndicating a large industrial property in Brisbane with forecast cash returns of 7.65%, but it comes with hefty upfront costs

    The Brisbane property being syndicated by Augusta

    Augusta Funds Management's latest property syndicate should give investors plenty to chew over as they weigh up the implications of investing into the Australian market through a syndicated structure.

    Augusta is seeking to raise up to A$17.75 million from investors and another A$14.2 million in bank debt via the Nudgee Road Property Trust, which will acquire a large industrial property not far from Brisbane Airport.

    The main attraction of syndicated investments is that they allow mum and dad investors with relatively small amounts of cash to tap into the relatively high returns provided by larger commercial properties which would normally be out of their reach.

    The minimum investment in Nudgee is A$50,000 and it's forecast to provide pre-tax cash returns of 7.65% in its first full year, rising to 8.0% in year two, with cash distributions to be paid monthly.

    So there's an obvious attraction for people such as retired folk because of the relatively attractive income stream it's expected to provide.

    However they need to weigh up the expected returns against the costs and limitations of investing through a syndicated structure, and investing into the Australian market adds an extra layer of complexity to that.

    Fees, fees, fees

    Property syndicates are costly to set up with substantial up front coats that are paid out of their investors' equity.

    Nudgee is no different and its main set up costs include an A$874,000 establishment fee to be paid to Augusta, up to A$408,250 in brokerage fees to be paid to Augusta for overseeing the sell down of units in the trust, mainly via Bayleys Real Estate, promotional expenses of A$204,298 and legal fees of A$165,379.

    And because the property being purchased is in Australia, there is stamp duty and associated fees of A$1,697,881 to be paid.

    All up, the Nudgee scheme will have total up front costs of A$3,509,608, which works out at A$9886, for every A$50,000 that investors put into the scheme.

    That reduces their NTA (Net Tangible Asset backing, essentially the initial value of the investment after costs have been deducted) to A$40,114 for every A$50,000 invested.

    So on day one of the scheme's commencement, investors will lose almost 20% of the value of their investment, which has to be recovered over time from any future gains in the property's value.

    That may take some time, but schemes such as this are generally long term in nature.

    Like most syndicates, Nudgee does not have a termination date or a redemption facility and its units are not listed on a stock exchange.

    Investors will generally get their capital back, plus or minus their share of any capital gains or losses, when the property is sold and the trust is wound up.

    Capital gains tax

    If investors wanted to cash up early, they would need to try and sell their units in the trust privately.

    And Australian capital gains tax (most likely at 15%) would apply to the sale of the property.

    So there's some uncertainty around how long the scheme will last for, how much of their original investment investors will get back and when that will happen.

    Both the monthly distributions investors receive and their capital return at the end of its term, will also be affected by movements in the exchange rate.

    If the New Zealand dollar weakens against the Australian dollar, returns will be boosted when converted from Australian to New Zealand dollars, and if the New Zealand dollar strengthens against its Australian counterpart, returns will be adversely affected.

    So schemes such as Nudgee can provide attractive returns, but there's a lot for investors to think about before they commit themselves.

    See our beginner's guide to property syndicates here, and if you are interested in the commercial property market, check out our Commercial Property Sales page.

    And click on the link below for a copy of the Nudgee scheme's Product Disclosure Statement:

    PDF iconAugusta_-_Nudgee_Rd_Property_Trust_PDS_July_2017 (1).pdf

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  • Gareth Morgan vies to protect renters with longer leases, eviction restrictions, improved insulation funded by ETS proceeds and more social housing

    Gareth Morgan's The Opportunities Party has released a policy explaining how it would like to reform the Tenancy Act to better protect renters. 

    Below is a copy of the media release. You can see a full copy of the policy here. 

    The Opportunities Party has a bold new plan to address the major problems confronting New Zealand, housing affordability.

    While TOP’s ground-breaking Fair Tax System will stop residential properties being misused as tax free investment vehicles for the wealthy and suppress rampant house price inflation, TOP believes structural reform of the rental and social housing markets is also needed to solve the country’s most pressing social issue.

    TOP will adopt a German type model to vastly improve the rights of private market tenants while demanding minimum standards for all homes and gifting current state housing stocks to non-profit social housing organisations.

    The Opportunities Party intends to develop a deep market for long term rental accommodation so that families can be secure knowing that investing in home ownership is not the only way that security is achievable.

    Party Founder and Leader Dr Gareth Morgan says, “Homes not Houses will alter the profile of New Zealand home ownership so the modest and low incomed no longer need to climb the mountain of home ownership in order to create a stable long-term home for themselves and their families.”

    The ability to evict tenants will be greatly reduced and rental properties will need to be sold with existing tenants in residence. While market rents will still apply there will be regulations to prevent existing tenants being priced out of their homes.

    The benefits of this policy package do not accrue to tenants alone. Reducing the social disruption of constantly moving home will result in less stress on families, higher educational achievement and reduced spending on social services to address the problems caused by that disruption.

    “Solving the housing crisis isn’t just about increased building or decreased prices” says Dr Morgan, “It’s about the way a civilised society should regard residential property as a social asset for an entire nation rather than a financial asset for a select few”.

  • Iain Fulton sees the ageing world presenting significant savings and productivity challenges to this and subsequent generations of investors and workers

    By Iain Fulton*

    In a world of falling bond yields and low inflation, the ‘Search for Income’ has become a popular phrase in capital markets over the last decade or so. This paper aims to look at some of the demand side factors which may be driving this appetite and what it might mean for investors over the long term. Demographics remain the great predictor of many of the social challenges we will face in our lifetimes so we can look towards life expectancy, retirement age and dependency ratios to help understand the scale of the issues we face.

    Next, a careful assessment of long term historic returns from varying asset classes can at least offer a guide as to how different assets behave under different holding periods and economic conditions. Patrick Henry to the Virginia Convention in 1775 stated that ‘I know no way of judging the future but by the past’.

    We may feel that we are in an environment of unprecedented technological, demographic, social and political change and if so, why should the returns of the past be any guide? Yet the past has also been characterised by rapid technological change, periods of inflation and deflation, numerous financial crises and any number of wars, coups and revolutions. So what lessons can we take? And how should we invest to meet our investment objectives in the future?

    The challenges we face – longer retirement periods
    A brief history of social security - how were retirement ages set?

    In 1889, Germany became the first nation in the world to adopt an old-age social insurance program. Otto von Bismarck, Germany’s Chancellor designed the system and it was outlined in a letter to the German Parliament by Emperor William the First. William wrote, “those who are disabled from work by age or invalidity have a well-grounded claim to care from the state.”1 Initially, Bismarck’s system set the retirement age at 70 (far above life expectancy) though it was reduced to 65 in 1916 (18 years after Bismarck’s own death).

    The US followed Germany’s lead but not until 1935. At that point, when the US Committee on Economic Security were drawing up the legislation, they were split as to whether to choose the precedent set by Germany (65) or to adopt the older age of 70. State level pension-provision which pre-dated the Social Security Act of 1935 were split also –half of the States setting retirement age at 65 and half at 70. When the Federal Railroad Retirement System in 1934 chose 65, that seemed to tip the balance and Franklin D. Roosevelt signed the decree which set retirement age at 65 in the US in 19352. With Germany and the US leading the way, most other countries fell into line and 65 was accepted as a fairly standard universal retirement age.

    With retirement ages set in the early 20th Century, it may come as a surprise that global pensionable ages for men and women have barely changed since the days of Bismarck and Roosevelt. In fact in some cases, they have fallen. And all of this despite significant gains in life expectancy. Figure 1 below sets out retirement ages for men and women globally. The countries shaded dark having older retirement ages while those with lighter shading have younger pensionable age. We can see that these ages are still little changed with the majority of the population globally able to retire between the ages of 57 and 65 dependent on location and demographics of each country.

    Figure 1a: Retirement Age for Men

    Retirement Age for Men

    Source: – retirement ages globally

    Figure 1b: Retirement Age for Women

    Retirement Age for Women

    Source: – retirement ages globally

    If we begin to think about life expectancy when 65 was set as a retirement age in 1935, we can gain insight into what assumptions policy makers made at the time. Figure 2 below shows the world in 1935 when the US Social Security Act was passed. The chart plots Life Expectancy against real GDP per capita. The size of the bubble represents the number of people in that country in that year.

    Figure 2: 1935, life expectancy, Real GDP per capita and population size

    1935, life expectancy, Real GDP per capita and population size

    *Showing a free slide from, CC-By Licence

    We can see that in 1935, the actuarial cost of providing social security benefits to the world population was incredibly low as almost no one was expected to live long enough to enjoy any sort of retirement at all! After the Second World War the picture began to change but still relatively slowly as can be seen in the corresponding chart for 1950 in figure 3.

    Figure 3: 1950, life expectancy, Real GDP per capita and population size

    1950, life expectancy, Real GDP per capita and population size

    *Showing a free slide from, CC-By Licence

    With only a few countries having life expectancy beyond pensionable age (and even then only 5 years or so), the whole system still seemed fairly sensible with manageable costs in 1950.

    Rolling the clock forward to today, the picture looks very different. With so many people expected to live well beyond retirement, sometimes for 20 years or more, the demands on our savings and social security systems have become enormous and far beyond the terms upon which they were originally drawn up.

    Figure 4: 2015, life expectancy, Real GDP per capita and population size

    2015, life expectancy, Real GDP per capita and population size

    *Showing a free slide from, CC-By Licence

    The fact is, as people become wealthier they live longer and the last 65 years have seen dramatic increases in life expectancy around the world. This places greater pressure on our savings as retirement periods lengthen and our holding periods for investments extend into the future. Raising retirement ages is clearly politically unpopular (particularly since the elderly make up a large part of the electorate), but it would appear that as time goes by, retirement ages are likely to rise.

    The burden on existing taxpayers for the care of the elderly and general state level funding as society ages becomes even greater as we look into the future. By 2050, 22% of the world’s population will be over 60 up from just 11% in 2000. This will place significant pressure on government finances and the savings people need to retain standards of living into their twilight years.

    Figure 5: Percent population over 60 – 2015 and 2050

    Percent population over 60 – 2015 and 2050

    Source: WHO, Global Age Watch Index 2015

    It may not be all bad news. The pressure on traditional state level pension and social security systems has been obvious for some time now. As a result, private saving for retirement has become much more widespread than in the past as the Social Security Agency finds that 61% of all workers and 80% of married couples are at least saving in a retirement plan3. There is also the suggestion that as we age we spend less although it’s not clear if this is simply due to declining incomes or an intrinsic desire to save late in life.

    With long retirement periods and a growing elderly population, the demands on people’s savings seem fairly evident. Also, the productivity needed to deliver growth and prosperity from a smaller proportion of the population who work, most likely implies that disruptive technological and competitive change will be a constant. These are important considerations when we begin to think about our investment objectives and how we go about achieving them over the very long holding periods that we should have.

    Savings – What should investors do?
    The verdict of history versus the hyperbole of financial news outlets.

    The excitable pundits on financial news channels constantly aim to capture our attention with the latest sensational story about company XYZ who ‘beat’ earnings by X% and ‘raised guidance’ by Y with the stock trading up by Z% ‘after hours’. These stories get the adrenaline going for some and are obviously important signals in their own right. Far from sparking interest though, it can cause the eyes to glaze over as each story blends into the next and we listen to the most exciting thing that happened since well, the day before yesterday. Does this coverage really help investors keep their long term investment objectives in perspective? More often than not, these short-term movements in individual prices are more important to the value of employee stock options than they are to whether or not you or I are going to have enough money to see us through our retirement if we are fortunate enough to get that far.

    It’s not great TV to compare the long term holding period returns between asset classes like stocks, bonds and T-Bills over similar time frames (10, 20 or 30 years) to the holding periods needed for savers to build up that all important nest egg. Yet this is exactly what Professor of Finance at the Wharton School, University of Pennsylvania Jeremy Siegel does in his book ‘Stocks for the Long Run’ (McGraw Hill, 2014). The study looks at the best and worst real returns in stocks, bonds and bills going back more than 200 years in the US for various holding periods (1, 2, 3, 5, 10, 20 and 30 years4). The results are shown in Figure 6 below.

    Figure 6: Highest and Lowest real returns on stocks, Bonds and Bills over 1-, 2-, 5-, 10-, 20- and 30- Year holding periods 1802 – 2012

    Highest and Lowest real returns on stocks, Bonds and Bills over 1-, 2-, 5-, 10-, 20- and 30- Year holding periods 1802 – 2012

    Source: Prof. J Siegel, “Stocks For the Long run”. McGraw Hill (2014) p94

    A glance at the chart shows why equities are the domain of the financial news channels. The range between the best and worst returns over one and two year periods is much wider than those for bonds or bills. It is this volatility that creates the excitement but also may get in the way of the true long term merits of equities as an asset class in their own right. When one looks to the longer term (i.e. more in line with investors’ true expected holding period), the risks in equities in real terms are far lower. Indeed, the worst 30 year holding period return for equities since 1802 is actually a positive 2.6% in real terms while the best at 10.6% per annum is still well ahead of bills and bonds. Even on time periods of 5, 10 and 20 years, the empirical evidence from history suggests equities offer a more favourable trade-off between risk and reward.

    Is history a relevant guide for our future path however? The list of challenges we face today seems endless. Whether it is from disruptive technologies (artificial intelligence, autonomous vehicles, electric vehicles, machine learning, big data, algorithms predicting our every move, robotics, virtual reality, augmented reality, the internet of things and cloud computing to name a few); political upheaval (a maverick in the White House, the threat of EU collapse, an unstable Middle East and a shifting balance of economic and political power in Asia [also globally one could argue], high budget deficits in the West); social problems (an ageing society, income inequality, youth unemployment, mass migration), how can we reliably use history as a guide?

    As a historian, I would argue that at times of maximum uncertainty, history remains one of the best guides we have – perhaps not for the detail, but at least for the bigger picture. The 200 year period under observation above included the Industrial Revolution and related mass urbanisation (similar to that seen in parts of Asia over the past 50 years); two major World Wars and any number of regional conflicts; bouts of hyperinflation and outright deflation; countless financial crises; the invention of the motor car, the TV, mobile phone, internet and dramatic advances in healthcare and life expectancy. Yet equities have still delivered positive real returns over all 20 and 30 year holding periods over the last 200 plus years. Regardless of the short-term headlines on financial news channels, why would investors choose any other asset class if their time horizons are genuinely a 20 or 30 year time period over which they need to save?

    If loss aversion is a concern from an investment in equities, we should always view this in the context of our holding periods. For example Professor Siegel points out that “an investment made at the peak of the market in 1929 was back in the money after 15 years and since World War 2, the recovery period for stocks has been even better. Even including the recent financial crisis, the longest it has ever taken an investor to recover an original investment in the stock market was the 5 year 8 month period from August 2000 through April 2006”5.

    The study offers some interesting insights around the suitability of equities as a long term store of value. But the data so far is focused entirely on US returns. How do other countries fare? Do varying economic outcomes at the single country level have a significant effect on returns between asset classes? Professor Siegel presents data for individual countries in Figure 7 below.

    Figure 7: International Real returns on stocks, bonds and bills 1900 - 20126

    International Real returns on stocks, bonds and bills 1900 - 2012

    Source: Prof. J Siegel, “Stocks For the Long run”. McGraw Hill (2014) p89

    We can see from the table that individual country returns do vary. Stocks however, have delivered better real returns than the other two primary asset classes across the board. Also, the above average performance of the ‘World’ would suggest there may be benefits of some geographic diversification.

    So far, we have explored the scale of the savings needs our generation and those that immediately follow have. Our holding periods for the investments we make matter and ours may be longer than we think. It is important to retain that perspective. We can also assume that to avoid excessive pressure on state budget deficits as the working population falls as a percentage of the whole, productivity (and likely the retirement age) must increase suggesting change will be a constant. Yet change has also been a constant over the last 200 years and looking at the returns from equities over the holding periods most relevant to those with the greatest savings challenge in the future, this asset class has come closest to delivering the real returns we require. The chutzpah on financial news channels may give equities a bad press over short time periods but Siegel’s careful analysis of historic returns suggests his book “Stocks for the Long Run” is aptly named.

    Why do dividends matter?

    As life expectancy has risen and holding periods for investments have become longer, it’s natural that in our advancing years we have a tendency to seek income such that we can at least afford a lifestyle somewhere close to that which we enjoyed when we were working. The demand for income in this sense doesn’t appear like it will go away any time soon. However, this isn’t the only reason investors should value the humble dividend. A number of academic studies point towards enhanced returns and lower volatility from dividend paying stocks relative to their non-paying counterparts.

    Siegel again breaks down the historic returns on stocks into their component parts. Namely dividends, dividend growth, earnings growth and capital gains for various periods between 1871 and 20127.

    Dividends, Earnings and Payout Data for Various Historical Periods

    Dividends, Earnings and Payout Data for Various Historical Periods

    Source: Prof. J. Siegel, “Stocks for the Long Run”. (McGraw Hill, 2014) p145

    The data shows that dividends over the whole period have been by far the most important source of returns for investors. Even after the Second World War as tax changes and a desire to reinvest from retained cash flow caused companies to reduce their payout ratios, dividends still accounted for the majority of the total return achieved during that period.

    If dividends make up the majority of the long term returns on stocks, it’s worth also considering other academic evidence that suggests high dividend portfolios can actually deliver higher returns with lower volatility than portfolios with other dividend characteristics. Conover, Jensen and Simpson published their piece ‘What difference do dividends make?” in the Financial Analysts Journal in November 2016. They present the statistics in figure 8 below.

    Figure 8: Returns by level of dividend (3 year rolling holding periods, 1962 to 2014)8

    Returns by level of dividend (3 year rolling holding periods, 1962 to 2014)

    Source: Conover, Jensen and Simpson. “What difference do dividends make?” Financial Analysts Journal November/December 2016

    The results show that a high dividend yield portfolio (4.4% annual yield) delivered higher average monthly returns over 3 year time periods with a lower standard deviation than equity portfolios with low, no and extreme (6.3%) dividend yields. Broadly consistent with the findings of Siegel, it is also interesting to note that dividends also accounted for a significant proportion of the overall return.

    Dividend Signalling — Beware of Fake News

    It seems fairly clear that dividends matter. They hold the key to the long term real returns historically earned by equities and, for the savings challenges facing us today, dividends may yet have a significant role to play. However, as we can see from chart 8 above, not all dividend strategies are created equal. Extreme dividends can often be a signal of financial stress where the capital requirements for a company or industry have changed. This can increase volatility and reduce returns. For example, the newspaper industry changed dramatically in the early 2000s as its audience moved on-line. The stocks had very good cash flow, strong and stable earnings historically and above average returns on assets. However, the attractive dividend yields which presented themselves proved unsustainable as the competitive pressures intensified. The resultant industry collapse can be seen in Figure 9 below.

    Figure 9: US Newspaper Ad revenue in real terms from 19509

    US Newspaper Ad revenue in real terms from 1950

    Source: The Newspaper Association of America


    The ageing world presents significant savings and productivity challenges to this and subsequent generations of investors and workers. Change will no doubt remain a constant, as it has been throughout the last two centuries in particular. On balance, equities should represent a good investment when viewed in real terms against the long term time horizons we need to consider – despite their higher levels of volatility in the short-term. Further, historic evidence from achieved returns suggests the humble dividend still has a significant role to play.

    The newspaper industry example however, suggests a careful approach is required to ensure the long term prospects and competitive dynamics of the companies and industries we invest in are taken into account. We should take a view on the level of income and cash flow, the sustainability of the returns and the valuation attached to the dividend paying companies we invest in. If our long term objectives in real terms are to be met, it is vital that the cash flow streams which back our dividends are sustainable into the future.


    1. US Government – Social Security Agency / History,

    2. US Government – Social Security Agency,


    4. Prof. J Siegel, “Stocks For the Long run”. McGraw Hill (2014) p94

    5. Prof J Siegel, Stocks for the Long Run (McGraw Hill, 2014) p8

    6. Prof J Siegel, Stocks for the Long Run (McGraw Hill, 2014) p89

    7. Prof J Siegel, “Stocks for the Long Run,” (McGraw Hill, 2014) p145

    8. “What difference do dividends make?” Conover, Jensen and Simpson. Financial Analysts Journal November/December 2016

    9. The Newspaper Association of America – published data

    Iain Fulton is the Global Equity Investment Director for Nikko Asset Management. He is based in Edinburgh, UK. This article is used with permission,

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