Don't limit options: sell before you have to

Columnist·

22 Mar, 2002 07:30 AM8 mins to read

By MARY HOLM

You said, in a recent column, "On retirement, while you should move money you'll need over the next few years into a fixed-interest investment, the rest could stay in the share fund for quite a few more years".

Why move your share market money through a fixed-interest investment?

Good on you. Many retired people live too frugally so they can leave money to their family. I like to see the younger generations discouraging that.

But the main point of your letter got me thinking, until I talked to some investment experts.

It seems that returns on shares aren't superior enough to justify putting your grandmother in a position in which she must sell shares to get her income, regardless of what's happening in the share market.

"The secret of investment is never to be a forced seller," says one expert.

If your Nan sometimes has to sell at particularly low prices, that can badly hurt her overall returns. She needs to keep her options open.

The expert suggests your grandmother, and others in retirement, should hold the money they'll need in the next three years in cash, including term deposits.

Money they expect to spend in the next two to 10 years should be in corporate bonds, and money to be spent after seven years - or perhaps left to others - should be in shares.

For the average family, with a mortgage-free home, there's no need for more investment in property.

The overlaps in periods are to allow for differing risk tolerances and to give flexibility.

To maintain the suggested asset allocation, over the years your Nan will shift money from shares to bonds and from bonds to cash.

To some extent, that second move will be taken care of when bonds mature.

But she will also need to review her position - perhaps once or twice a year - with the idea of selling shares and perhaps bonds.

Here's where the flexibility comes in.

She can sell if market prices are reasonable. But if prices are low, she can put off the move until her next review.

What's this? After my saying over and over that nobody should try to time markets, I'm now suggesting they do?

Not really. This is a much longer term, more general market view.

Let's say, for instance, that Nan was reviewing her situation after last September's sharemarket plunge.

Many experts at that time were pointing out that shares have pretty much always rebounded within a year of such drops. Nan might have noted that, and delayed her sales for a few months, or even a year or two.

Why not? If she had started the previous year with, say, three years of income in cash and seven years in bonds, there would be no rush to top up those "accounts". She could do it when the markets had recovered.

In answer to your comment about negative dollar cost averaging, I'm not afraid of it. But it does have a couple of drawbacks:

* With normal, "positive" dollar cost averaging, you invest the same amount regularly, regardless of what's happening in the share market.

That amount buys more shares or units when prices are low, and fewer when prices are high. That brings down your average price, which is great.

But the opposite happens when you're selling investments. You sell more when the prices are low, which brings down your average gain.

* With positive dollar cost averaging, it's not so bad when the market falls. Your loss is only a paper one. When the market recovers, you do, too.

With negative averaging, when you sell in a down market, you've turned a temporary loss into a permanent one.

Despite all this, it's still good to sell gradually over time.

If you need money for a specific item in, say, five years, you don't want to risk selling the lot at that time, in case it's in a market downturn.

It's better to plan to sell portions, perhaps six monthly or yearly, so that at least some of your sales will be at high prices.

And, with time up your sleeve, you can be a bit flexible about when you sell.

I'm always disappointed to read letters from your readers telling of bad experience with investment advisers.

I understand how they feel because from time to time, people are referred to me, being unhappy with the advice they are receiving.

Some of the portfolios I see can best be described as junk. It is interesting that often these come from advisers working for high-profile franchisers working to a formula, often to meet agreements with a limited number of managed funds or in-house products.

This destroys objectivity and raises serious issues of conflict of interest. The experience these investors have dirties the water for those who are more skilled and truly independent.

I am pleased you make the point there are some good advisers around and that investors should ask the adviser how they invest their own money.

May I clarify one point?

You say that asset allocation is much more important than asset selection.

I assume you have in mind the 1986 Brinson, Hood & Beebower research, which was widely believed to have said that.

But the authors have often pointed out this wasn't their conclusion. And, if you think about it, it doesn't make sense. I have sent you a 1997 article which clarifies their research.

Don't get me wrong, asset allocation, along with asset selection, is important, but for risk management.

To bring others up with the play, I said in the March 9 column, "Research shows that how you spread your money over different types of assets affects your returns much more than which particular assets you hold".

You're right. I did have the Brinson, Hood & Beebower research in mind.

As the article you sent says, "hardly anybody read the study itself". I certainly didn't. But for years, investment experts have been quoting it as saying that about 94 per cent of the return on a portfolio can be explained solely by asset mix.

Your article, from the Dow Jones Investment Advisor, casts doubt on that number. One critic actually says 15 per cent is more accurate, but that seems way too low to me.

Regardless of what the correct figure is, nobody knowledgeable is debating that a portfolio of all shares is likely to bring in a higher long-term return than one of all fixed-interest investments.

The tradeoff is that shares are riskier, particularly over the short term.

While the importance of asset allocation may have been exaggerated, I still say that the first decision in any investment plan - and a major one - should be how much of each asset type to go into.

My response to the first letter in today's column is an example.

Is asset allocation more important than subsequent decisions about which shares, share funds, bonds and so on to buy?

Who cares? They both matter lots.

I've heard about too many people with all their long-term savings in term deposits, and too many others with money they need in six months' time in shares.

I make no apologies for continuing to stress the importance of correct asset allocation.

In response to your information on financial advisers, I would just like to suggest that you also consider The Shape of Money website as an additional website for recommendation to your readers.

We try very hard to ensure that it is a source of "Free, independent and comprehensive personal financial information for New Zealanders".

The information on financial advisers is under "Savings and Investments", then "Before you Invest", then "Getting the Right Advice".

I'm not in the business of publicising websites, but your one does look useful and seems to give sound, unbiased advice.

A bit of useless info for you - irrelevant to the point you were making a few weeks ago.

However, Winston Churchill's shortest speech was a bit longer than such a lot of people believe.

I only learned the full speech recently because of a small assignment I had to do for a family member.

I gather the full speech was to Harrow school and went: "Never give in, never give in, never, never, never never; in nothing great or small, large or petty - never give in - except to convictions of honour and good sense".

Just for info; not for publication.

But I must publish your letter. I'm one of the "such a lot of people" who got it wrong.

I did say that Churchill, "so I'm told", once made a seven-word speech. Still, I should have looked it up.

Had I done so, in my trusty Wordsworth Dictionary of Quotations, I would have found the same words as yours.

* Mary Holm is a freelance journalist and author of Investing Made Simple. Send questions for her to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@pl.net. Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number. Mary cannot answer all questions, correspond directly with readers, or give advice outside the column.