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The Income Conundrum

It is almost 10 years since the beginning of the Global Financial Crisis (GFC) and most asset prices are now as high, if not higher, than before. Here in New Zealand, you would have to have been living under a rock not to be aware of what has happened to property prices over the last few years, and certainly since 2013.

However there is one type of investor that has been left behind, and their plight to a certain degree has been forgotten amongst all the media hype to do with rising asset values, particularly that of Auckland property. That investor, of which you will almost certainly be one of, is the Fixed Income Investor.

THE FIXED INCOME INVESTOR

“Fixed Income” is just a fancy term for any investment where the investor by investing their capital, in return receives a set amount (or fixed) amount of return. The most common fixed term investments New Zealanders would be familiar with Bank Term Deposits.

TEN YEAR CHART OF THE OFFICIAL CASH RATE

Source: IRESS

As you can see from the Ten Year Official Cash Rate (OCR) chart, interest rates are currently the lowest they have been at any time since the GFC. This is most significantly felt by the average person by the interest rates they receive from the Trading banks on their Term and Call Deposits.

AN EFFECTIVE 60% PAY CUT FOR INVESTORS

Investors who were receiving approx. 8% on their 1 year bank Term Deposits in 2007 are now only getting 3.1% - 3.4%. That’s an effective drop in annual income of 59.4% from what they were receiving ten years ago. Or to put it another way, it would be like a wage earner going from earning $60,000 p.a. to now only earning $24,000 p.a.

YOU CAN’T LIVE OFF ASSET PRICE GROWTH

Of course those same Term Deposit investors would have likely benefited from significant asset price growth since 2007 if they were owner/occupier of their own home, or directly owned investment property. But that asset price growth would not have come close, and in the case of an owner/occupier not at all, to offsetting the reduction in income from the dramatic fall in Term Deposit interest rates. Asset price growth is all well and good, but it does not pay the day to day bills or provide ongoing sustainable income to live off.

THE SHARE MARKET AS A SOURCE OF INCOME

It would be fair to say that most New Zealand investors consider the Share Market in its entirety as a risky place to invest money, and only appropriate for ‘professional’ investors. The reality couldn’t be further from the truth. A Share Market is a place where individual companies can list their shares (i.e. equity) to either raise capital and/or offer their shareholders a facility to either reduce or increase their shareholdings (i.e. provide liquidity). In New Zealand we have the highest income paying Share Market in the developed world, matched only by Australia.

BUT ISN’T THE SHARE MARKET AT A HIGH LEVEL AS WELL?

Given what is reported in the media, it is easy to understand why the average investor would think that the Share Market is well above levels of yesteryear. But this is definitely NOT the case. It’s a bit complicated to explain, but the S&P/NZX50 Gross Index, as reported in the media, is a Gross rather than a Capital Index. A Capital Index tracks only prices but a Gross Index tracks Prices and Dividends. The easiest way to understand this is that a Gross Index does not drop when a company in it pays a dividend. This is counter intuitive as the company is worth less as it has paid out cash, and its share price on the market drops accordingly. But the index doesn’t reflect this drop. This would be like if there was an investment property index (to track investment property prices), for that property index to include historic rent payments in the value of the index. Seems strange right? But that’s effectively what the S&P/NZX50 Index, which is quoted in the Media does. It is the Capital Index that shows the reality of what New Zealand’s Share Market has done over the past 10 years.

OK, SO HOW HAS THE SHARE MARKET DONE OVER THE LAST 10 YEARS?

TEN YEAR CHART OF THE S&P/NZX50 CAPITAL INDEX

 Source: IRESS

As you can see from the 10 year chart on the previous page, it shows that share prices in the Top 50 companies on the New Zealand market only got back to their 2007 levels in August 2016, and in fact they were back at those levels only 9 months ago. So while it is true the market is at its highs, since May 2007 when the index was 3,317 the market has gone up 375 points at its height of 3692 on the 23rd August 2017. So that is 11.3% in 10 years or just over 1% per year. Think about what property prices have done over that time. Given that, which asset class would you think may be over or under valued, Shares vs Property, relative to each other?

SO IF AN INVESTOR WAS LOOKING FOR INCOME FROM THE SHARE MARKET, WHAT TYPE OF STOCKS SHOULD THEY CONSIDER?

Income investors would typically like to own shares in companies with defensive earnings, meaning their ability to pay dividends is not highly dependent on economic conditions. Luckily for New Zealand Investors, the New Zealand Share Market has a relatively high number of these types of companies to choose from. They are typically monopolistic, market dominant, and/or tangible asset owning companies and have stable cash flows to maintain a high level of dividends, relative to their share prices, to shareholders.

I WANT MORE REOCCURRING INCOME THEN WHAT MY TERM DEPOSIT/DIRECT INVESTMENT PROPERTY INVESTMENTS ARE CURRENTLY GIVING ME – WHAT SHOULD I DO?

First of all, call your HHG advisor! If you don’t know specifically who that is, that is no problem, any of the advisors here at Hamilton Hindin Greene will be more than happy to talk to you. They then can talk through with you ways to increase your income at a level of risk that you are comfortable with. To give you an idea of potential options an investor might look at if they would like to more income and were considering the Share Market, please consider the following table:

CONCLUSION

As part of an appropriately structured portfolio, investments in high yielding companies on the New Zealand Share Market can significantly boost the amount of income your investments produce.

So if you are not happy with accepting what the banks are offering, and/or the return from your investment property income is not worth the hassle, perhaps adding some defensive high yielding share market investments may be a good alternative

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