Break all Term Deposits and Invest in Cheap Shares

[Sauce]

Yes paying too much for a home can affect your later wealth in a significant way, no argument there. The problem is a buyers need for housing may not neatly fit within a down cycle in the property market.

Sauce, you provide a good argument against overstretching your financial resources, which I agree with. Save more than the minimum deposit required if you think this will be an issue. IMO you have presented an argument against irrational exuberance and buying property, not a justification to rent instead of buying.

SNOOPY

The real point I was making is that your idea that ENPs goal was "to be able to buy a property in two years time no matter what" rather than his stated goal of "obtaining a house deposit faster" is born of the same kind of emotional thinking that drives the kind of exuberance that causes the financial destruction I outlined.

In your mind you have some view that ENP may have a personal situation that means this is a justifiable idea, but this is a general discussion, on an investment forum. Speculating about possible subjective circumstances so that your goal fits is not the right way to give general advice. Yes, of course some people have genuine lifestyle considerations that make home ownership important for them, but this is general discussion on an investment forum regarding a first home buyer.

You say "the problem is that a buyers need for a property may not fit neatly within a property market down cycle" But then you go on to suggest that if someone is going to stretch their financial resources they should "save a larger deposit". Hmmm.

Hang on a second. Didn't you just advise a first home buyer who wisely said they were looking for a way to achieve a larger deposit, that they should instead forgo a larger deposit to guarantee themselves that they could get into the property market on their desired date no matter what? That way they would hedge themselves if prices were to rise rapidly, and that their goal of home ownership was more important than the negative financial considerations of your strategy?

I believe you understand what I am getting at Snoopy, but you are intentionally steering the conversation to subjective detail and semantics, and not addressing the real point.

It is better advice, generally speaking, for first home buyers on average, to consider the entire situation. They need to consider their deposit size, loan servicing ability, how rising interest rates in the future will affect their loan servicing ability, AND whether the price they are paying is reasonable and if the market is overheated or not. Some judgements about an uncertain future will have to be made but given the information available good decisions are very achievable.

It is way too simplistic to advise someone that to "achieve home ownership in two years" they should link their investment returns with house prices, so they are in no better or worse position in regards to their deposit percentage, and that way if house prices go crazy again, they will still be able to buy the house. This is simply NOT good general advice for the average first home buyer - and it has elements of irrational exuberance to it - even though you may justify it through speculating about unknown lifestyle considerations.

If a first home buyer cares about owning a house so much that they are happy to wear substantial costs and risk much lower future purchasing power to do so, then your advice might suit them - but it will be a minority that it is right for. As general advice, on an investment forum, for the average first home buyer, it not very good advice.

Regards,

Sauce.

[Sauce]

P.s. My example wasn't a justification to rent instead of buying in general.

But while house prices are still so high relative to incomes I think there is a strong argument and saving/investing for a bigger deposit and for renting over buying. At least as a better financial strategy for those with low deposits i.e. most first home buyers. As their deposit grows and wage inflation catches up with house prices (which I suspect it will in the medium term) or house prices come down to meet wages, then a more optimal purchasing time will present itself. I suspect this is akin to what ENP had in mind, but regardless of my speculation about his intentions, I think its acceptable advice for the average first home buyer at this current point in the property cycle.

[Sauce]

The problem is I cannot be sure that world energy prices and NZ demand will continue to go up. Nor can I be sure that Ryman will be able to retain their construction margins, particularly in the light of the competition for workers for the coming Christchurch rebuild. So how can I compare the future earnings effects of these two statements on the respective companies? In truth I can’t, and I don’t think anyone can.

The beauty of investment is that you don’t have to choose in a situation such as this. The wisest investment decision in this case, IMO, is to invest in both companies. Provided of course that you can buy them at the right price.

SNOOPY

Well I disagree that no-one could compare Contact and RYM and make a wiser decision between the two in terms of which has greater odds of superior returns. I can also say with confidence that your lack of CHCH builders theory is unlikely to derail RYMs excess profitability in the short term either - in fact it could well be good for them as they are the only ones with in-house construction resources so its the competitors that are more likely to suffer. But those are distracting discussions so lets not go there...

Reading your post it appears you have changed the reasoning behind your 'hedging strategy' during the course of the discussion. Lets review your original thesis:

using the product/service hedging investment philosophy, you do not need a crystal ball. You invest and whatever the result in two years time you will wear it. If power costs are high, so are your dividends from Contact. If power costs are low you take a haircut on your Contact investment but your power bills will be offsettingly low.

Since then you have wisely acknowledged the opportunity costs associated with the view that lower power bills provide downside protection and abandoned it. Your argument has changed to one that really sounds more like diversification. Holding a basket of assets across different sectors to protect against uncertainty is a perfectly acceptable strategy. But the reality is there is simply no need to try and make such links between your own personal costs and those investments. Diversification, and inflation beating returns, can be provided without thinking about personal costs. Just make diversification across sectors part of your portfolio weighting strategy.

So, lets look at your worked travel example:

A real example: In my own case I seem to end up taking a fair few aeroplane flights each year. Following my hedging investment theory, I should buy some shares in an airline. But I do have a good understanding of the airline business to the extent that I don’t believe I can find an airline investment that I would class as ‘good’. So I have expanded my investment horizon from ‘airlines’ to ‘tourism’. I have found a tourism investment that I understand and like, Sky City Entertainment. So I regard my ‘travel’ money as my investment in Sky City. You may think this Sky City/Travel connection is tenuous. But I feel it is necessary, as the first priority in any investing is that the underlying investment is good, even at the expense of making the investing hedging less concomitant.

Here you are pointing out that the closer you stick to the hedging idea, the more it narrows your investment choices meaning you may not be able to invest in good businesses. Since you intuitively know this is stupid, you abandon the hedging idea to find an investment with better odds of success and then you slap a tenuous link to travel in your mind, I can only assume to tickle some form of sentiment.

Please tell me Snoopy, exactly what is the benefit you feel you derive from this idea of linking your personal costs to your investments?

If you had initially phrased your point as "A good strategy to hedge against inflation (destruction of purchasing power) is to hold a diversified basket of high quality businesses that have the ability to pass on their own rising costs to customers" then I would have applauded that strategy (it is my own). However whether the products and services of those businesses are directly related to your own personal costs is completely inconsequential. Your own personal purchasing power will simply depend on the success of your portfolio.

Regards,

Sauce

[Snoopy]

Reading your post it appears you have changed the reasoning behind your 'hedging strategy' during the course of the discussion. Lets review your original thesis:

Snoopy wrote:
“Using the product/service hedging investment philosophy, you do not need a crystal ball. You invest and whatever the result in two years time you will wear it. If power costs are high, so are your dividends from Contact. If power costs are low you take a haircut on your Contact investment but your power bills will be offsettingly low.”

Since then you have wisely acknowledged the opportunity costs associated with the view that lower power bills provide downside protection and abandoned it. Your argument has changed to one that really sounds more like diversification.

You have me wrong Sauce. I haven’t changed my position on investment hedging as regards energy. In fact earlier this year to satisfy the lack of energy shares in my portfolio I added some more Contact. I guess you would regard that as an emotional purchase which I have subsequently been punished for (recent acquisition price $5.90). However since my overall average holding price for Contact shares is $4.60, I am not so worried about my investment timing.

I should add that I regard resources that are consumed (milk and electric power in my own portfolio case) and where demand is increasing to be good investment prospects. Provided, that is, these commodities come from low cost generation sources that are sustainable. My main objective is to maintain a resilient portfolio, and yes that does mean diversification.

But the needs of life are diversified. So I think that I can have both a diversified and an investment hedged portfolio all at the same time. There is no need to go in one camp or the other.

If you had initially phrased your point as "A good strategy to hedge against inflation (destruction of purchasing power) is to hold a diversified basket of high quality businesses that have the ability to pass on their own rising costs to customers" then I would have applauded that strategy. However whether the products and services of those businesses are directly related to your own personal costs is completely inconsequential.

There is another reason I practice investment hedging that I haven't discussed before. If I invest in something with some connection to my lifestyle, I will automatically be in touch with market developments just by living. And I will be interested in keeping up with the news on the subject. Better information in without consciously trying should ultimately help my investment performance.

SNOOPY

[Snoopy]

So, lets look at your worked travel example:



Here you are pointing out that the closer you stick to the hedging idea, the more it narrows your investment choices meaning you may not be able to invest in good businesses. Since you intuitively know this is stupid, you abandon the hedging idea to find an investment with better odds of success and then you slap a tenuous link to travel in your mind, I can only assume to tickle some form of sentiment. A casino as a travel hedge? I think even people that buy into the product hedging idea would struggle to swallow that one.

From my experience when I travel by air I always have to stay somewhere and eat somewhere. Given that Sky City Entertainment run both hotels and restaurants, I think SKC makes a good travel hedge. The casino side of it I understand you may find a bit hard to swallow. But although I don’t go casinos, I might go to a show or a sporting event or an exhibition or some form of ‘entertainment’. I regard the ‘casino bit’ of SKC as a substitute for those. Holding SKC as an overall ‘travel hedge’ still works for me.

SNOOPY

[Snoopy]

The real point I was making is that your idea that ENPs goal was "to be able to buy a property in two years time no matter what" rather than his stated goal of "obtaining a house deposit faster" is born of the same kind of emotional thinking that drives the kind of exuberance that causes the financial destruction I outlined.

Sauce, I may have been bringing in information from another thread. I am sure that ENP has stated within the last twelve months on this forum, although perhaps not on this thread, that his aim is for he and his partner to buy a house in 2-3 years. I think ENP has also mentioned that if he had saved his deposit sooner then he would buy sooner. He saw the sharemarket dip and wondered if this would be an opportunity to buy shares while they were cheap and so do just that (assuming share prices would return to normal levels within two years). He didn’t state that last clause. I inserted in brackets. But it was implicit.

Following that I recall that you and I both agreed that given the timeframe of one to two years was short in investment terms, ENP might find it best just to keep saving using cash and term deposits. At least at that point you recognized that no matter how good that share-buying opportunity looked, it might not be the right thing for ENP to do. At that point you recognized that putting all his capital into the sharemarket might have a downside even though the odds were probably weighted for ENP coming out ahead.

Since then you have trotted out this “obtaining a house deposit faster” line. Suddenly the fact that there could be a downside is forgotten or deemed irrelevant as a sub optimal outcome of what at the time might seem at optimal investment strategy. I don’t see why you suddenly changed your position as regards downside risk Sauce. The excuse you trotted out, that:

“ENP only asked after obtaining a house deposit faster”,

doesn’t wash with me.

If ENP had instead posed a different question:

“I have found an investment strategy that would allow him to obtain my house deposit faster, a one way adjustment to my savings strategy with no downside risk, so should I do it?

Then this would have been one of the shortest threads on Sharetrader. Everyone would have said:
“ Yes, do it.”, and they would have been right.”

Instead ENP asked about “obtaining a house deposit faster”, because he knew that any strategy suggesting piling his savings into shares had risk. You are right Sauce in that ENP didn’t say:

“What about this idea of obtaining a home deposit faster, factored against the possible downside risk?”

But ENP didn’t need to put in that last clause. Because it was implied by him asking the “obtaining a house deposit faster” question on its own. If ENP did not want us to consider downside risk (because he saw it as a near zero probability, nothing to worry about outcome) he had no need to pose the original question in the first place! He would have just bought the shares without posting the original question.

SNOOPY

[Snoopy]

You say "the problem is that a buyers need for a property may not fit neatly within a property market down cycle" But then you go on to suggest that if someone is going to stretch their financial resources they should "save a larger deposit". Hmmm.

Hang on a second. Didn't you just advise a first home buyer who wisely said they were looking for a way to achieve a larger deposit, that they should instead forgo a larger deposit to guarantee themselves that they could get into the property market on their desired date no matter what? That way they would hedge themselves if prices were to rise rapidly, and that their goal of home ownership was more important than the negative financial considerations of your strategy?

Sauce, I said that if ENP wanted to get into a house in 2-3 years he should consider investment hedging a part of his deposit in an investment linked to house prices. The part of the deposit to hedge would depend on his tolerance for the volatility of his total investments. I did not try to second-guess the direction of house prices in the meantime. I did not try to ‘logicalize’ ENPs request to be in a house within 2-3 years. I took that goal as a given. I did not make any judgement on whether this is right goal for ENP. I don’t know ENP’s full circumstances and nor do I wish to know them, and nor do I need to know them to answer his question. Negative financial considerations of my strategy are one possible outcome, yes. These are balanced by being able to afford a more expensive house if house prices in general rise. You don’t get something for nothing.

It is way to simplistic to advise someone that to "achieve home ownership in two years" they should link their investment returns with house prices, so they are in no better or worse position in regards to their deposit percentage, and that way if house prices go crazy again, they will still be able to buy the house. This is simply NOT good general advice for the average first home buyer - and it has elements of irrational exuberance to it - even though you may justify it through lifestyle considerations, as many did who will now be regretting it.

The hardest step getting into the housing market is the first step Sauce. If you make a mistake by paying a little too much for your first house, provided you can deal with the mortgage payments you will not be perpetually badly off.

Logically, and this may seem counterintuitive until you think about it, you should hope that the value of the first house you buy goes down. Why? Because if the market in general keeps going down then the cash bridge you will have cross to upgrade to a better house will be shorter. Ideally the value of each house you own should go down all through your working life as you upgrade. Then right before the last chapter where you sell up to go into a retirement village, then and only then will it be a good thing if your house price rises.

With your accountant brain fired up Sauce, you will be of the opinion that aspiring to own a perpetually devaluing asset throughout your working life is poor advice. However, in terms of the quality of the house you are living in, space and features per dollar, I hope you can see that you will live in a far better quality home throughout your life if the property market is as weak as possible for as long as possible. Here ‘emotional weakness’ in buying a so-called overvalued property has resulted in you leading a higher quality home environment life, throughout your life. Overall, I seriously doubt that most people who moderately overpaid (with the benefit of hindsight) for their first house live in the constant state of regret that you think they do. Sometimes the maligned emotional thinking solution turns out to be the right one.

SNOOPY

[AMR]

23,000 / 0.05 = 460k

Credit has relaxed enough to allow first home buyers 95% finance again if you are keen on that option...no complex risk analysis, hedging, etc.

Mate of mine bought 2 bedroom house in Kingsland (walking distance to Eden Park) for $415k.