For most of my clients, I tend to recommend no more than 10% of total share allocation towards NZ shares. For lower income earners, the percentage is even lower because the benefit of imputation credits is reduced.
Imputation credits
For NZ shares, you pay tax on dividends received. Imputation credits are basically credits that companies attach to their dividend payouts to shareholders. This means companies pay the tax and pass on that credit to you, so you don’t have to pay the same tax again. Just note, that company tax rates and personal tax rates differ, so you may still be required to pay some tax. For example, companies pay tax at a rate of 28%, and your fund may be taxed at a higher rate. You would pay the small difference, but generally, most of the tax will be paid by the companies issuing the dividends.
As you may imagine, having little to no tax to pay is a significant head start for an investor over funds where you have to pay tax (such as international shares).
new Zealand based funds allocation towards nz shares
This will be why a lot of NZ based balanced and growth funds have a significant allocation towards NZ shares.
When looking at a funds asset allocation, particularly a mixed asset fund such as conservative, balanced, or growth, you should look at shares only. What I mean by that is a balanced fund for example may say 15% NZ shares and 35% international shares and you may think that looks OK. A 15% allocation towards NZ seems reasonable. But it isn’t a 15% allocation towards NZ. It is a 30% allocation towards NZ. Only 50% in this example is allocated towards shares, and 15% of that 50% is towards NZ, which is 30% of the overall share total.
A lot of NZ based funds sit at around 25% allocation of its total share allocation towards NZ shares. Some higher.
It got me wondering why I am recommending a much lower percentage to NZ shares than most of the fund providers. Is the risk of investing so much towards NZ shares worth it?
A lot of kiwis earn an income in New Zealand. We have houses and other assets in New Zealand too. Why so much into NZ shares as well? Do the imputation credits help that much?
nzx50 returns 2004 TO 2025 (21 years)
So I did what any data junkie would do and dove into the numbers.
First, I looked at the returns (including dividends) of the NZ share market (NZX50) for the 21 year period Jan 2004 to Jan 2025. The results are a 9.12% average, and 8.22% annualised.
Annualised is an investors actual returns in the pocket, and is lower than the average because years in which the returns are negative, it takes subsequent larger gains to return to even. For example, if you lose 20% in a given year, it takes a 25% gain just to get back to even. This makes in the hand returns less than average returns, but it is the more important number. All we should care about is what we receive in our pocket. So, annualised returns is the figure we will use moving forward. 8.22% for the NZX50 over the last 21 years.
If 100% of an investors dividends had imputation credits attached and the investor had a tax bracket of equal to or lower than the company tax rate, you would pay no tax and your returns would be the same as the fund itself. 8.22%. Most NZ based funds have PIE versions and 28% is the maximum PIE tax rate, so this situation should apply to many kiwis.
That’s great. No tax. Case closed right? We can now overload our NZ share allocation like many of the NZ based PIE funds do. Not so fast. We need to compare the returns to another market.
US500 returns 2004 TO 2025 (21 years)
In this case we will look at the returns of the US500 market over the same period (last 21 years).
The US500 (including dividends) has returned 10.38% annualised over the same period. Much more than the 8.22% with the NZX50. However, as international investors, we are subject to more taxes, known as FIF tax.
This is how much your returns would reduce by under different tax brackets:
2004 to 2025 US500 annualised returns after payment of FIF tax at different tax rates
COMPARISON OF THE NZ50 AND THE US500 AFTER TAX RETURNS (2004 TO 2025)
If your income tax bracket is 10.5%, your returns would be 1.63% a year higher with the US500 fund, even including the benefit of imputation credits and the payment of FIF tax. As your tax rate increases, the difference reduces. A 33% tax rate for example, and the difference between the NZX50 and the US500 after tax is 0.48% in favour of the US500.
Have a read here to see the impact of a 0.5% difference in fees, or play around with the impact of investment fees calculator here.
Of course, the past is not a predictor of the future. That saying is plastered over every fund managers document. But 21 years is a lot of information to go by, and if you are to predict anything, you would expect international markets to outperform NZ markets over the long term.
So why is it that so many fund managers in NZ have such a high allocation towards NZ shares?
NZX50 - HIGH RISK LOW REWARD (COMPARATIVELY SPEAKING)?
If NZ shares (even when including the tax benefit) did outperform international shares then maybe I could understand a significantly high allocation towards New Zealand. Although I would still remain skeptical over the amount of risk of investing so much into a small market.
But if the returns are the same or worse, then why would we invest so much towards New Zealand? Equal or worse returns for much higher risk? No thanks.
New Zealand is such a small market relative to the world, so to place an outsized portion of our assets towards New Zealand carries a lot of risk. For that risk though, you would want a lot better than the results of the last 21 years where the gap between NZ and US shares has been around 2.16% annualised (10.38% vs 8.22%). Unless you are on a 39% investor tax rate, you may want to question your fund providers allocation towards NZ shares, as you have not even been close to making up that difference.
Even if returns were the same in NZ as internationally, I would still only likely recommend 10% or less towards New Zealand. Just for the fact we represent such as small portion of the world and there in no clear performance related reason to invest so much here. Technically, NZ makes up less than 1% of the world’s output, but I still like outsizing your allocation towards NZ a little more than that just because of the head start tax wise. Cost savings are something you can control and there is a lot to be said for that. But I don’t like to allocate as much as most. The numbers don’t stack up.
Don’t let the tax tail wag the dog. Tax should never control your financial decisions. Tax should play a smaller part in your decisions, not the starring role.
Although imputation credits close the gap in performance, it has not been by enough over the last couple of decades to justify investing as much as many investors and fund companies do in my opinion.
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The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here