Break all Term Deposits and Invest in Cheap Shares

[Sauce]

Hi ENP.

Yes, that its a totally flawed way of thinking. For instance, one might feel happier owning CEN because power prices were rising, but the business only generates returns on equity of 5%. RYM generates returns on shareholders funds of 30%.

Simply put, the investor in RYM will be able to pay for a lot more power in ten years than the investor in CEN.

Snoopy knows this of course, and undoubtedly would have been assuming you were still going to buy a good business within the property sector, but it still doesn't make sense to me.

Things might be even worse if subconsciously you were not so worried about turning the lights off at night because you owned CEN. Sounds far fetched but it similar thinking in my opinion. Now that would be a perverse incentive.

Regards,

Sauce

[Sauce]

P.s. All funds I could get my hands on is, as of today, fully invested. Personally, I think you would be very wise to do what you are considering, and if it was me I would do the whole lot..

DYOR of course and good luck, you sound like a smart and independent thinker who can go against the herd, so share market should be a good match for you.

[AMR]

ENP, are you still looking to buy investment properties?

[Snoopy]

Hi Snoopy,

Your posts are usually littered with good sense and rationality, but I simply do not follow this logic at all.

The way I see it, the only rational decision for ENP, were he to cancel his term deposits, would be to invest in what he believes has the greatest odds of beating his cost of capital - i.e. his term deposit rate rate + break fees - regardless of other considerations. If the choice of vehicle is equities this would usually mean the best quality business at the best available price. And this may, or may not, have anything to do with residential real estate.

If you need a deposit for a house in say two years time Sauce, then 'good sense and rationality' would see you not invest in the market at all. Why? Because I think ENP is disciplined enough to reach his home deposit goal by just saving salary and using term deposits. ENP would achieve his objective with next to no risk this way. Now I know we are all sharemarket investors and no-one wants to hear the 'don't invest' message. Indeed, if ENP had, say, a six year time horizon before buying a house then I would tend to agree with your investment strategy Sauce. It is ENP's two to three year time horizon that I see as the issue here.

I think if ENP put all his term deposit money in carefully selected 'recession proof' shares today, he would likely do very well in two years time, maximise his return on capital in your terms. However as Liz points out you cannot be certain of this. What happens if in two years time just as ENP is readying his house deposit money Italy gets downgraded to junk bond status? We could end up with another sudden market plunge. And what was looking like a nice deposit for a home is bled of cash overnight. ENP is back in the rental market, through no fault of his own. And how is he going to explain that to his significant other?

While I think the chances of such a financial disaster is low, the consequence of the unlikely happening is very significant - ENP doesn't get his house. That is why I don't buy your maxmise your return philosophy Sauce, in this case.

Limiting yourself to the property sector to link your potential loss or gain to residential property prices, is simply madness.

Even if it was a sound strategy, it would be big stretch of the imagination to assume that any 'business' could provide this speculative volatility 'marriage' to residential property 'prices' - the extreme amount of variables in businesses returns, not even to mention the market forces of both shares and property, are just too complex. No business returns or share price returns are likely to follow residential property prices with any predictability at all.

P.s. For the record I am all for ENP using the funds to buy RYM. Wise choice in my opinion. But for very different reasons than Snoopy!

I have to admit to slightly gritting my teeth as I wrote my last post Sauce.

Yes I know a speculative sharemarket volatility 'marriage' to residential property 'prices' will never quite work. But I think that if there was ever any hope of such a fit, Ryman and residential property is probably about as good a fit as you are ever likely to get. I also know that ENP has studied Ryman before and been an RYM shareholder before. And I know that Ryman is a soundly run company for all sorts of reasons that you are well aware of. So for ENP, investing in Ryman would not be a spur of the moment decision, as he would have a pretty good idea exactly what he was investing in.

Personally I am not invested in Ryman, because while I am convinced of long term soundness of the business model, I am not convinced of the relative bargain status of RYM at this time. But then again I would say exactly the same thing about buying property in Auckland. This is another way that my 'match' loosely works.

SNOOPY

[Snoopy]

I agree Sauce.

I don't understand these people that buy investments as a "hedge"

Hedge against bank fees by buying WBC, ANZ, etc. Hedge against electricity prices by investing in CEN. I think this is silly thinking.

It reminds me of this Martin Hawes article... http://www.martinhawes.com/recent-articles.shtml

He is hedging against oil buy investing in NZ Oil and Gas.

If you want to hedge against something, buy the best performing asset you think rather than simply investing because of what industry it is in and the expense you are trying to hedge against.

I hadn't seen that Martin Hawes article before ENP. I think you have to consider that Hawes IMO primarily writes for people in the 50+ age bracket, with retirement in their sights, and those already retired. For this age group I would argue his article largely does make sense.

For someone such as yourself with decades of work time ahead of you should you choose it, the Hawes article is probably less valuable, except in one sense.

'Company choice lifestyle hedging' does mean that you focus on what is important to you and not what 'the market' is doing. Doing this I think will lead you out of being blinded by day to day market happenings that are injurous to your wealth. And less savvy investors who only see the 6pm news and think day to day share price movements are important in a long term investment plan, are likely to reduce their 'noise trading' if they consider their investments as more of a hedge.

Having said I basically agree with Hawes in context, there is one failure of logic in this referenced column that I see. NZO may be loosely in the oil industry. But it is not seriously correlated with pump petrol prices! Hawes, IMO, would be much better owning NZR if he truly wanted to stick to his fuel hedging plan!

SNOOPY

[Snoopy]

For instance, one might feel happier owning CEN because power prices were rising, but the business only generates returns on equity of 5%. RYM generates returns on shareholders funds of 30%.

Getting off topic, but I think you will find things are not as simple as that Sauce. CEN may only generate an ROE of 5% on the book value of their assets. But IIRC, the book value of CEN assets was magically increased a few years ago to better reflect the market value of those generation assets. All of that magical increase in generation asset value has gone indirectly into the pockets of shareholders. If you look at the ROE on the original floated value of those assets, I believe it is far greater than 5%.

SNOOPY

[ENP]

ENP, are you still looking to buy investment properties?

My own home rather than investment property. Intend to buy a house with my long term partner in 2013 and rent out the spare rooms.

[ENP]

If you need a deposit for a house in say two years time. It is ENP's two to three year time horizon that I see as the issue here.

Yes my time frame is 2 years.

We could end up with another sudden market plunge. And what was looking like a nice deposit for a home is bled of cash overnight.

I am aware of this.

And how is he going to explain that to his significant other?

I don't think I would want to. It would be pretty gut wrenching if this happened.

I also know that ENP has studied Ryman before and been an RYM shareholder before.

It's the only company on the NZX I'd be happy to invest in. I know more about this company that any other investment in the world.

So for ENP, investing in Ryman would not be a spur of the moment decision, as he would have a pretty good idea exactly what he was investing in.

As per above. I have studied this company's annual reports, etc since it started.

[ENP]

In the big scheme of things, this is basically to accumulate my house deposit faster.

My half share for a deposit is 45-50k (me and my long term partner will go 50/50) so should achieve this in 2-2.5 years time with my current savings levels.

If I was to invest in shares (RYM) and achieve say a 30% return after those 2 years, then my 23k will grow to roughly 30k. After tax will leave me with a little under 6k. It takes me about 7-8 months to save that. So I will have my house deposit 7-8 months faster. Likewise, if I keep the same time frame, I will have a larger deposit.

However, if say the shares lose 30% of 23k then I will be left with 16k from my original 23k. That 7k will take me 8-9 months to save additionally, meaning I will have to postpone out house purchase for 8-9 more months.

I intend to sell the shares when I have accumulated enough deposit (45-50k) no matter what has happened to them, if I sell at a loss then so be it.

[buns]

ENP

Mate you are learning fast

I don't know many who are at your age, with that much capital, and have read all the 'no brainer' or 'sure thing' stories on this site and others yet kept on the sidelines. Good work. You seem to have the head for it. This is all totally the opposite to how I began.

I've merely scanned this thread but also put 1 vote towards cashing up and buying undervalued shares. Hopefully you have spent the last 6 months finding these values and should be able to pull the trigger pretty quickly with the cash in hand. If this research has not been done, be careful, take a step back and maybe learn from this (not being ready), as you are young and these situations (or similar) will return.

Another thing. On that house, remember the market (price of your shares) may not look like how you want it in x months/years. Share prices could be 20% above your 'value' in 3 months, or could be 20% less than 'what you pay' for them in 2 years. Who knows? That is the market, that is why these discounts are here today. Over time, the price will come back to value.

If you HAVE to have this house on date x, I don't think shares are for you. You will understand this, but may have missed it as we always think about differences between value and price when wanting to enter a share, not exit.