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Research shows that Aotearoa is significantly underinsured, meaning many New Zealanders are likely to have inadequate protection. Globally, Aotearoa ranks 26th out of 56 OECD countries for insurance spend, at 3% of GDP, compared to the OECD average of 9.4%. This puts the country between Chile and Colombia in the league table.
Inadequate protection means that when faced with a shock event, many households and whānau will be unable to recover. A UK study found that a third of households moved into a lower income quintile after a shock event, and 20% fell into poverty. For a portion of New Zealanders, insurance can be the barrier between financial resilience to shocks and falling (back) into poverty. [i]
This report covered all types of insurance, of which life insurance is a significant part. So why have life insurance? Let’s look at four key reasons:
Where a family has one significant asset (such as a farm or another kind of business) and more than one child, ensuring an equitable inheritance for all the children is not simple. Selling part or all of the asset may not be desirable, particularly to the current owner who sees it as their legacy. It is unlikely that the family has more than one asset of similar value.
One option could be to purchase life coverage on the life of the current owner. On their passing, the pay-out would provide those not inheriting the business with a substantial sum by way of compensation.
In many families, there is a sole (or at least principal) breadwinner. The loss of their salary would have a dramatic impact on the family’s wellbeing and future plans. However, it is perfectly possible to protect this income, either partially or completely.
If you purchased coverage of ten times your income and that pay-out was invested and provided a yield of 5% per year, the family would receive 50% of your salary indefinitely.
Example:
Worth paying for some peace of mind?
You are one of, say, three director-shareholders in a successful business. The business is valued at $6,000,000. Assuming equal shareholding between the three, if one dies, their widow or widower will probably be expecting to receive around two million dollars for those shares. Do the surviving shareholders have that money on hand? Perhaps, but probably not.
If you can’t find the money, then the widow/widower may well be able to sell the shares to someone who can—perhaps a competitor.
Insurance can be written for all the shareholders, ensuring that their families can be paid out swiftly and easily without causing further anxiety and distress at what would already be a difficult time.
By far the most common reason. The bank wants to know that if the person paying back their debt dies, the money will still be repaid. For many people, this requirement that has been imposed on them represents the sum total of their coverage. This simply shows how underappreciated the coverage really is.
New Zealanders are leaving themselves unnecessarily exposed to the hands of fate. Life insurance can often be a very affordable way of providing more certainty and peace of mind, for yourself, your family, and any business partners.
Please do not hesitate to get in touch to discuss your personal situation and obtain professional advice on this and other financial planning matters.
[i] Underinsurance poses a threat to inclusive progress in Aotearoa, Deloitte New Zealand, 9th February 2023
For decades many Kiwis have relied on term deposits and residential property for their investment portfolios. The share market has been comparatively ignored. Personal finance expert, Mary Holm, attributes this to the damage caused by the stock market crash of 1987.
That crash was certainly brutal, and more so here than anywhere else in the world. The late Brian Gaynor provided an excellent summary of the excesses that led to this crash, in an article in 2017. While the world’s major stock markets fully recovered within twelve months, he states that the New Zealand’s market has never reached that height again. I would suggest that that is hard to conclude this with certainty as the calculation of the index has changed a few times since the crash.
None the less it’s unsurprising that this crash, in addition to the abject performance of the New Zealand market through the 1990s and 2000s, has made property investment a lot more attractive for many Kiwis.
In addition of course you have the power of leverage. In no other area is it normal for a retail investor to borrow almost all of the money that they invest. If you want to invest $10,000 in the stock market then you typically have at least $10,000 in the bank first. Whereas if you want to buy a house for $100,000, you might only need to have $15,000 personally. While on the face of it borrowing to invest seems extremely reckless, with property it has proven a shrewd move time and again.
The graph above shows that house prices have more than tripled since 1992 (the year that the Reserve bank began collating data). Whereas the New Zealand market has risen eight-fold and the average World market has risen by a multiple of eleven.
However as property investors would typically use leverage then their net result is often more impressive. If you invested $10,000 to buy a $100,000 house in 1992, it would now be worth $320,000. At 5% interest your loan over that period would have cost $174,000. So your original $10,000 would have netted you a profit of over $134,000. A thirteen-fold increase.
Almost double the $70,000 profit from investing the same in the NZ market and comfortably exceeding the $100,000 profit from investing in the World index. What was even better was that the cost of the mortgage reduced the tax that you paid on the rent and there was no tax to pay on the sale of the property.
At this point it has to be said that New Zealand is almost unique in enjoying this picture of property investment benefits. Most other developed countries have been taxing property investment for decades and the result here is certainly enhanced by the lack of data pre-1992. One would be forgiven for concluding that property investment must be a one-way bet. However the data only covers a period that has been exceptionally kind to investors in all areas. In the UK and America, the housing price crash of the late 1980s for example led not just to “negative equity” (mortgages worth more than the property) but tens of thousands of repossessions due to rising interest rates. Imagine losing your home or investment property and still owing the bank many thousands of dollars.
For investors in New Zealand property the environment has changed dramatically. The “Brightline” rules could lead to many being taxed on any profits that they make. The gradual removal of mortgage interest relief radically changes the overall return made from holding the asset each year. Add to that rising interest rates, rising inflation and a looming recession. Suddenly, investing in property is far less attractive. So if not property, then where? Obviously the rising interest rates, rising inflation and a looming recession are detrimental to almost all investment assets. The only positive one can find is that they are likely to produce an attractive buying opportunity in the long run.
“Diversification is the only free lunch” in investing[i] However when the environment becomes more challenging, diversification becomes a particularly powerful aid. The implication being that you are hedging your bets, and so have a greater chance of avoiding an overall loss. If you had $50,000 to invest and opted for property, then the whole lot would have to go into one house. No diversification would be possible. Conversely in the stock market, you could spread this amount across a wide variety of areas. You could also invest some in the stock market and some in, say, gold or more esoteric areas such as fine wine or financing opportunities. Some investments will go up, some down. Even if all go down, some will go down less!
So the main purpose of diversification is to help preserve your capital. It is not necessarily a recipe for riches. By definition if one holding gains in value while another falls, then the net effect to cancel one another out. This is why the legendary investor, Warren Buffet, said:
“Diversification is protection against ignorance. It makes little sense if you know what you’re doing.”
I would argue, however, that with the number of factors working against investors it’s harder to “know what you’re doing” now than it has been for several years.
Assuming that we agree diversification can help prevent significant loss, then where should one diversify to? Of all the threats that investors face right now, inflation is the most ominous. Certainly from a long term perspective at any rate. While it’s a friend to borrowers it is the ultimate destroyer of wealth. By some estimates, New Zealand property values effectively fell by 40% between 1974 and 1980. Over the course of the 1970s, net property values actually stagnated. This was due to inflation.
I would therefore argue that investors need to ensure they hold assets with a decent chance of rising by at least the same rate as inflation. Most alarming for investors unnerved by the sudden change to this new environment is that this therefore excludes cash from the options. While right now it may prove a prudent place to be in the short term – though one should bear in mind the danger of the Open Bank Resolution here of course – in the long term interest rates are extremely unlikely to come close to matching the inflation rate. So cash in the bank is falling in value day by day right now.
An insightful article by The Economist[ii] assessed a number of assets that may be assumed to do well during times of inflation. In relation to these two the writer agreed that in the past both infrastructure and farmland have performed well during inflationary periods. Leases are often linked to inflation, tenants are responsible for most costs, and debt used to purchase them is eroded by inflation. JP Morgan Asset Management calculated that when inflation exceeds 2.5% then these assets beat the stock market. However as the Economist article states:
“That might all sound very alluring, but it should come with health warnings. For one, performance has become harder to predict: think of retail space and office blocks (under threat from e-commerce and remote work), airports and power plants (exposed to decarbonisation) and even farmland (vulnerable to climate change). The asset class may require a greater appetite for risk and more homework than its backers are used to”
The most famous retainer of purchasing power. There are countless examples of how the metal has retained its worth. Frankly I find some hard to believe and the evidence provided is often less than conclusive. One of the best reasoned that I have found is as follows:
“In the era of Emperor Augustus (27 B.C. to 14 A.D.), a Roman centurion was paid 15,000 sestertii. Given that one gold aureus equalled 1,000 sestertii and given there was eight grams of gold in an aureus, the pay comes to 38.58 ounces of gold. At current prices (2013), this is about $54,000 per year. The centurion who commanded 80 legionaries is roughly equivalent to a U.S. Army captain. The current wage for a captain is $46,000 – which is fairly close.” [iii]
Over shorter periods there seems to be a far weaker correlation between inflation and the price of gold. Certainly in my experience gold experts predictions prove to be among the most inaccurate of any in the investment industry. Therefore I do not view it as an asset from which you are likely to profit significantly. But as a retention of purchasing power – over the very long term at least – it appears to be hard to dismiss.
Metals used in construction, oil and gas used for power (and manufacturing), agriculture producing food. Commodity prices often drive inflation. As these are all part of the supply required for modern life, this is referred to by economists as “supply-side inflation”[iv]. Therefore investing in this area can prove to be an effective way of dealing with inflation.
These are typically issued by Governments rather than companies. Where bonds offer a fixed interest payment, and so will fall in value when inflation rises and this income becomes less attractive, an inflation-linked treasury or gilt (bond) will provide an income that increases with inflation. Problem solved? Well, not quite.
Bonds, unlike shares, typically only exist for a set period of time. Say ten years. At the end of this period the issuer repays the debt to the holder of the bond. A bond is issued for $100 and repays $100. During times of inflation, inflation-linked bonds become much more attractive and so their price rises. Looking at a range of “index-linked” Treasuries, we find the following current prices:
When these treasuries mature, the holder will receive $100. So the purchaser of the first one will receive $10 less than they paid (a loss of 9%). The purchaser of the second one will receive $47 less than they paid (a loss of 32%). Buying them now is betting that you will receive more in interest (coupon) than you’ll lose on the sale/redemption. In other words betting that inflation will stay elevated for a significant part of the remaining term.
Where most investment is focused on buy-low-sell-high, at it’s most basic a hedge fund seeks to profit from market falls as well via sell-high-buy-low. That is selling a stock it doesn’t own at a high price, and borrowing the stock from a bank to complete the sale. Then once the price has fallen, buy the stock and repay the bank.
This action was immortalised in the fantastic book by Michael Lewis (and the film of the same name) called The Big Short. During the Global Financial Crisis a small number of investors correctly predicted that the market was going to crash. Their bet meant selling without owning (known as “shorting”) in the hope that the crash would make them rich. One investor not mentioned in the book was a hedge fund manager named John Paulson. His bet against the market before the GFC meant his firm made a profit in 2009 of $15 Billion. Under normal hedge fund rules, 20% of that would be paid to the manager.
Hedge funds are typically successful when there is a trend to exploit or a sudden big move in the direction that they are predicting. When markets are simply fluctuating up a little, down a little, hedge funds find it very hard to be profitable. Many lost money over the past decade as they continued to bet against a rising market. Many more were often exposed as mirroring traditional fund strategies (but just charging higher fees) as they failed to protect investors in previous down turns.
A few, however, are doing rather well now. The S&P500 is down 18% so far this year. I know of hedge funds that are up by that same amount. Out performing the market by over 35% is impressive.
It has to be said that these assets are not suitable to all. This is sophisticated investing typically involving significant leverage. The managers can get it spectacularly right, like Paulson did in the GFC, or spectacularly wrong like LTCM which almost brought down the world’s financial system in 1998.
In short, hedge funds suit some investors and climates but by no means all. Proper advice should be taken before venturing into this area.
We are now in truly uncertain times. There are no longer any one-way bets. At the same time, sitting it out in cash only guarantees loss (of purchasing power). Some of the assets discussed may be suitable for most people. Some of the assets are only suitable for certain kinds of investors and strategies. Diversification is key as is taking proper advice.
[i] Nobel Prize laureate, economist Harry Markowitz, is reported to have said
[ii] Do physical assets offer investors refuge from inflation, September 11th 2021
[iii] https://www.hurriyetdailynews.com/roman-centurions-and-the-price-of-gold-today-46042
[iv] Where people drive up prices by buying more, this is termed “Demand-side” inflation.
