Mary Holm on investing

Mary Holm is a personal finance writer

Mary Holm: Weigh risk with worst case scenario

2 comments
When considering moving house, factor in suburb price drops and the possibility of losing your income

Leaving a home that is nearly mortgage-free, with space for the children to play in, to move to a more desirable suburb can be a tricky decision. Photo / Getty Images
Leaving a home that is nearly mortgage-free, with space for the children to play in, to move to a more desirable suburb can be a tricky decision. Photo / Getty Images

Q: My wife and I are having a philosophical debate around our next step in the housing market.

In our early 30s, we could be mortgage-free in our current house in seven years, with the house worth about $350,000. While we love the property and it gives us great outside space for the children, it is not somewhere we see ourselves living outside of the next five to 10 years. We are now looking at properties in a more desirable area where we can see ourselves living for the next 20 to 30 years. Entry-level houses there start at about $750,000.

The issue we are having is centred around when we make the move to the newer area. Do we wait until we are mortgage-free and take a sizeable deposit with us? This contains the risk of house prices in our target area increasing disproportionately to our income and current house. Or do we relocate now, take on the risk of a higher mortgage and ride the potential of higher capital gains in a more desirable area?

A: When you're weighing up risks, it's useful to work through some realistic worst-case scenarios. The two likeliest risks for you are probably:

• House prices move against you.

• You lose your job and can't get another good one, affecting your ability to make mortgage payments.If both of those happened, how might your two options play out?

If you stay in your current house until you've paid off the mortgage, house prices might rise more in the posher suburb - or fall less - than in your current suburb. Also, without work you might not be able to make your current mortgage payments.

Given that you've nearly paid off your mortgage, your lender would probably let you reduce the mortgage payments by extending the term of your loan. Still, that would delay your move. And even after paying off the mortgage you might have to save for a few more years to boost your deposit on the new place.

On the other hand, if you move to the "desirable" suburb now, taking on a much bigger mortgage, you could get caught if house prices fall there.

Without work you would have considerably more trouble making the larger mortgage payments. And extending the mortgage, or even making it interest-only for a while, might not cut the payments enough for you to manage.

You might be forced to sell the house and, because prices have fallen, you could end up with your house money considerably reduced. You might find that all you could afford would be a cheaper house than your current one.

It's pretty obvious which option is riskier. Furthermore, while capital gains might be higher in the posh suburb - as you say - so might capital losses. I don't have data on it, but it seems that prices in wealthier suburbs are more volatile. In the late 1980s I lost 30 per cent on a house in the classy suburb of St Heliers.

But let's not concentrate only on gloom. A clear advantage of the second option is that you will be living in your preferred suburb earlier.

Perhaps you should assess the chances of a job loss and think about how you would cope. For instance, family might help with mortgage payments for a while, so you wouldn't be forced to sell. That could make all the difference about which option to choose.

You've also got youth on your side. If things go badly wrong, you have years to recover.

If you do go ahead with a move, promise me one thing: you'll sell before you buy. The last thing you need is to be counting on getting a good price for the old place, but being desperate to sell because you can't cover two mortgages.

PS: I'm not sure Aristotle would agree that your debate is quite philosophical.

Q: The first two correspondents in your last column illustrate once again that many investors just do not understand how investment markets work. Having lost money on poorly performing assets, people seek to make up for lost time by trying again with more high-risk solutions. Your caution to both writers was exemplary.

My own experience is somewhat different. I am in my late 70s. After paying off the mortgage a decade or so before I retired, my wife and I set about building an investment portfolio which would generate income in retirement and some capital growth. We did this with the aid of a sharebroker and a couple of people whose opinions we value.

Most of this today is in shares, both here and overseas - either directly or in managed funds. And despite the big ups and downs of the last few years, which will unquestionably come again, our net dividend return is comfortably above current bank rates and the capital is largely intact. So it has worked well for us.

We bought gold shares back in 2005 but sold most of them recently at a handsome profit when the price seemed toppy. We have never had money in finance companies nor in any of these trading or property-owning schemes.

Some may argue that at my age we should have most of our savings in fixed interest, but I don't agree. We are not aggressive investors and have come to understand the relationship of risk and reward (and that you have to swallow hard at times). It's a pity more people don't; they'd be better off today.

A: They would indeed be better off today. But tomorrow, who knows?

I forwarded your letter to Craig Ansley, adjunct professor of finance at the University of Auckland, who crunched some numbers for us. He compared equal investments in New Zealand shares and fixed interest, taking tax and imputation into account and assuming you spent all the income, either dividends or interest.

The results were distinctly different for three periods:

• 1998 to 2003: Dividends were a bit higher than interest. But in the share investment, "you couldn't pull out at any time during that period without taking a big capital loss", said Ansley. In other words, share prices fell.

• 2004 to 2008: Dividends considerably exceeded interest for a while, but then fell below rising interest rates. Overall, though, dividends were higher. "And there would have been a capital gain or just a small capital loss if you pulled out early."

• 2009 to 2013: "Dividends are definitely better, but again there is a big capital loss if you pull out early."

Overall, says Ansley, "dividend income looks better after tax most of the time - largely because of imputation credits but in the last four years because of very low interest rates. But you have to be prepared to be locked in for the long term, because if you pulled out early you would take a capital loss that would swamp the income gain in years 1998-2003 and 2009-2013."

That, he says, is exactly what we would expect. "You can't get more income return (although you get a tax break from imputation) without taking more capital risk.

"If you stick around for the long term, you'll probably win. That's what higher expected return means. And if you're willing to stick around for the long term, there are perhaps better ways to secure income, such as longer-term bonds."

He adds that results of comparisons like this always depend on when you start. Over short periods, anything can happen in financial markets. Over longer periods, though, the relationship between risk and return always appears. The higher the expected return, the higher the risk.

That's not to say your investment strategy is bad. The money a retiree expects to spend in 10 or more years is probably best invested in widely diversified shares or a share fund, to get the likely higher returns than on fixed interest. Shares also offer some protection from inflation, because their values tend to rise with prices.

In your case, though, you have most of your money in shares in your late 70s. That's riskier than most experts would recommend.

I suggest that you - like our first correspondent today - think through a worst-case scenario. In your case, it would include a big drop in dividends to the point where you have to sell shares to get enough income.

We should note here that dividends are hardly stable. While interest rates plunged by more than two-thirds from late 2008 to early 2010, dividends dropped by more than half from late 2005 to late 2009.

And dividends tend to fall when earnings are weak, leading to weaker share values. In a worst case, a crisis in confidence might push shares down even further. You'd be selling shares at ugly prices.

Where would that leave you? If you'd still be comfortable, good on you. If not, you might consider moving some of your savings into high-quality bonds. I'm assuming you already have some in cash for spending in the next couple of years.

Q: I am a retired/unemployed person aged 60 (too old and no qualifications, was self-employed for most of my working life).

I'm living in a freehold house with my partner, a recent sickness beneficiary. I have just over $1000 in a KiwiSaver account and am wondering if I am able to cash it in to buy Mighty River Power shares?

I've only had KiwiSaver for about a year. Did manage to get a job short term, but it was too hard on my arthritic body.

A: The initial Mighty River Power share offer closed yesterday, but people will still be able to buy the shares on the stock market shortly.

But that's all academic, because you can't cash in your KiwiSaver money anyway. The only times you can withdraw KiwiSaver money before NZ Super age are if you are in big financial trouble, are seriously ill, move overseas permanently or buy a first home.

That's no big loss for you, though. I would never recommend anyone putting all their retirement savings - which I assume is the case for you - into a single share. There's too big a chance you will lose lots.

If you really want to invest in New Zealand shares, move into a KiwiSaver share fund. But at your age, it might be better to go with something less risky. If you're not sure of your current risk level, ask your provider.

Good on you for getting into KiwiSaver and good luck in finding another job.

Mary Holm is a freelance journalist, part-time university lecturer, member of the Financial Markets Authority board, director of the Banking Ombudsman Scheme, seminar presenter and bestselling author on personal finance. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary's advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it.

Send questions to mary@maryholm.com or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice.

- NZ Herald

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