Selling slumping investments not the wisest move

BY MARY HOLM

Q.An article in the Herald recommended that you do not convert paper losses into real losses.

This struck me as being clearly wrong, as surely (depending on costs and speed of converting) you should always view the current value as the real value.

The test I use is that if I had the money in my hand now, how would I invest it today? If that is different from my actual investments, it's time for a change (again, costs permitting). I thought this an interesting subject.

A.I can't follow your logic.

I agree that the current value of any investment is "real". It makes no sense to give more weight to its value at any other time than now.

I also agree that, if your current investments are not what you would buy if you had the money today, you should make changes, taking costs into account.

But that doesn't mean it's a good idea to convert paper losses into real ones.

For the benefit of others, we're talking here about investments in, say, shares or property that have lost value.

If the owner sells the assets, their losses are real. But if they hold on, the losses are only on paper. The assets may later gain value, and the owner may never suffer a real loss.

When you review your investments, it sounds as if you sell the ones that have performed badly. Sometimes, this is a good idea; often, it's not.

Let's assume that you started out with a portfolio that suits you. It should be diversified, and its riskiness should depend on when you think you will use the money and your tolerance for volatility.

If that's not the case, you should buy and sell until you have such a portfolio, regardless of investment performance.

Given, then, that you start from a good base, let's say that some time later you find that the 40 per cent you put into an international share fund has dropped in value and is now only 25 per cent.

The wise response to this is not to sell, but to buy more. If 40 per cent was right for you a few years ago, and your circumstances haven't changed, it's still right for you.

What money do you use? If, in the meantime, your 20 per cent investment in local shares or a property fund or whatever has risen to 30 per cent, you might sell some of those.

Or you could just put all your future investments into international shares, until you get back to around 40 per cent. This keeps down transaction costs which, as you point out, can make quite a big difference.

This strategy is called asset reallocation, and it's what the professionals do. One big advantage is that you sell what has done well lately, so its price is relatively high, and you buy what has done badly lately, so its price is relatively low.

It's not always easy to do, psychologically, though. Adding to your dogs and selling your winners is the opposite to what you, and many others, want to do.

And it's important to note that there's one situation in which you should sell your dogs.

That's when they really are bad investments, as opposed to good ones that have had a bad year or two.

You might find out, for example, that the fund you are in charges higher fees than other similar funds.

Or the company whose notes or shares you hold may be going through worse than a cyclical downturn, and seems headed for bankruptcy.

Or the neighbourhood in which you have a rental property might be deteriorating.

By all means get out of such investments.

But - once again assuming you had the right portfolio mix to start with - you should replace one share investment with another share investment, or property investment with another property investment.

Q. Having returned from Britain last year in a healthy financial position, my wife and I are heading in a downward spiral.

I have no real fixed financial plan and I am worried, yet my partner and I earn between us about $130,000 a year. We are aged 31 and 28.

My managed funds portfolio has performed poorly. My financial adviser says this is due to the strength of the NZ dollar against the US.

The managed fund split I have is 59 per cent equity, 33 per cent fixed interest, 2 per cent property and 6 per cent speciality. The amount is $41,000, which has dropped from $52,000 a year ago.

Their advice is to hold tight!

I also have about 1600 shares in Contact and the same in Auckland Airport shares, which at this stage I am happy to keep and not do anything with for quite some time.

My partner and I also bought a house last year, which has about $20,000 in equity.

And I have $20,000 sitting in my bank account - stupid I know as it is earning little interest. The plan was to use this for house improvements or to put on the mortgage.

My main financial goal would be to pay off the $180,000 mortgage as soon as possible, while also looking to buy a rental property.

To make matters worse, I have also invested about $17,000 in setting up a cafe, which I employ two staff to run. This is currently requiring me to put about $1200 a month in to keep it running.

The plan was for me to get this up and running well and then to flick it in 12 to 18 months.

As you can see there is no logic to my investments. And you can only read so many books! I need help to get me out of the quagmire!

A. Firstly, you should probably fire your financial adviser.

I'm assuming here that you invested in the managed funds last year, after you came back to New Zealand.

That's the same year in which you bought your house. There's a strong argument, then, that you should have put all, or at least most, of your savings into the house.

It's always possible that you hadn't planned to buy the house when you approached the adviser. Even so, your adviser should have questioned you enough to establish that a house purchase was a possibility.

He or she should then have suggested you put your savings into term deposits until your plans were clearer.

If the adviser was paid by the hour, that's probably what would have happened. It's likely, though, that he or she is receiving commissions for putting you in managed funds. So guess where your money is!

I should add, here, that I don't always recommend putting all savings into a house. If you also put some long-term money in a share fund, you get better diversification and learn about how the markets work over the years. Still, your main financial goal is to pay off your mortgage. So that's where most of your savings should have gone.

So what should you do now?

Given that you already have some money in shares, and probably paid entry fees to do that, you might as well leave that money where it is.

You are, after all, on high incomes and should be able to pay off your mortgage pretty fast anyway.

International shares certainly have performed badly lately, but that's all the more reason to stay put. You don't want to buy high and sell low.

In the long term, shares will rise again. Your adviser's counselling on that issue, at least, is good.

I'm not clear whether you're in a balanced fund, or have separate investments in a share fund, a fixed interest fund and so on.

If it's a balanced fund, you could perhaps move 59 per cent of it, or thereabouts, into a share fund. Often you can transfer from a balanced to a share fund for little or no fees.

Your $14,000-odd in fixed interest is a different story.

You will almost certainly be earning less on that money, after taxes and fees, than you are paying on your mortgage. You would be better off, then, using the fixed-interest money to reduce the mortgage.

The specialty and property investments are so small that it might be easiest to just put that money, too, in a share fund, or leave it as is.

Now, your other investments:

* The shareholdings in Contact and Auckland Airport are worth about $15,000.

With only two shares, you are too undiversified, which means you're taking unnecessary risk.

I suggest you sell up and put that money against your mortgage.

* Same with some of the $20,000 in the bank. But you might want to keep several thousand in the bank for emergencies.

* What you should do about the cafe depends on its prospects.

I suggest you hire professional help to assess what you are likely to sell the business for, now and in the future.

If its value is growing faster than the cash you are putting into it, keep at it. But if you're going nowhere fast, get out. There's no point in putting good money after bad.

* Hold your horses on the rental property.

I have concerns about rental property for homeowners anyway. You end up with most of your eggs in the property basket. And single rental properties are pretty risky. Some do really well; some bomb.

In your case, too, the cafe business must be rather time-consuming and worrying. Rentals can be the same.

I suggest you wait at least until the cafe is sold, and until your mortgage is much lower, before you take on another property. Even then, you might be better off in a share fund.

A good financial adviser, as opposed to a self-interested one, could help you to weigh that up.

One last thing: I think you've been a bit too harsh on yourselves. Your portfolio is well diversified. And that puts you ahead of many others.

* Got a question about money?

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* Mary Holm is a freelance journalist and author of Investing Made Simple.