Break all Term Deposits and Invest in Cheap Shares

[h2so4]

Haha, if thats true perhaps he should consider some wakefield hospital shares as well.

I am sure his wellbeing comes from munching on chicken wings and getting fat on dividends.
cheers

[Snoopy]

Ha!, I know Snoopy hedges fast food prices by buying RBD shares.

Very observant SSD, but my food hedging policy is a bit more general than that. I hedge food prices in general by investing in RBD. I know that long term the price of food in general should be correlated with the RBD share price, because RBD’s product range covers many food groups. As for the RBD product itself, I indulge very infrequently. Last month was a rare exception.

I visited KFC for the purpose of cashing in my shareholder voucher and to get my first taste of the new KGC wings. But not fancying any of the vege sides from the KFC menu (I looked before I went), I boiled up my own fresh vegetables at home, stuck them in a heat retaining plastic container then went along to order the chicken for my ‘big meal out’. Combined with the wings and apricot sauce, I reckon I got a moderately healthly dinner out of my visit. So no reason to get those Wakefield shares to hedge my health just yet!

SNOOPY

[Snoopy]

The fear of missing out on the home you have fallen in love with combined with the fear of having to pay a lot more if you don't get into the market soon. As we all know, chasing a rapidly rising market up can be a financially destructive thing to do. The housing market is no different.

Sauce, you perpetuate the myth that banks are just waiting to trick you into taking out as large a mortgage as possible so that when the market turns they can toss you out on the street and reclaim their cash in a mortgagee sale leaving you destitute and homeless. This is not a sustainable business model for banks. Banks do not enjoy doing this and do not plan to do this when taking on new mortgage clients. In fact they go to extreme lengths to make sure a mortgagee sale is not on any event horizon they can paint.

You cannot suggest that everyone who buys a property in a housing boom is financially destroyed. Whatever the market says about the value of you house, you are only financially destroyed if you can’t make your interest payments. Market valuations come and go. Acting on those capital market valuations is always optional.

SNOOPY

[Snoopy]

Snoopy wisely started to acknowledge my point about the opportunity cost that his strategy would wear. If he thinks about it hard enough he will realise that when the opportunity cost is factored in, owning contact shares to hedge against electricity prices and other so called 'consumer cost hedges' are in actual fact irrational. It might give people the warm fuzzies, but financially, it's not a clever way to think about investments.

Sauce there are certain so far undiscussed assumptions behind your ‘optimum investment savings’ strategy.

As a conceptual point, I believe you are assuming that you can plot all of your potential investment strategies on a unidirectional line. The zero point on this line represents stuffing your cash in your pillowslip each week (no risk). Move slightly along the line and you get to the putting all of your money in bank term deposits strategy. Move further along the risk scale and you come to listed property trusts. Keep going and you arrive at listed companies, the riskiest investments.

I should point out here that when I say risk, I am not referring to volatility. I am referring to the downside risk of losing the purchasing power of your capital.

Now one point where you and I agree Sauce is that the skilled investor can assess individual company investment risk and by prudent selection deliver an overall return higher than just investing in an index of all companies.

Do you subscribe to the single line risk model? If so the only rational thing you can do is choose the investment that makes the highest weighted sum of all possible scenarios return. This is no matter whether you are saving for a house or holiday or health. Picking the best performing strategy is the best you can do in all situations. This is as near as I can tell Sauce your position. If I subscribed to the same risk model I have described myself I would be in full agreement with your conclusion.

However, and this is the point you don’t seem to get Sauce, the reason I don’t agree with you is not that I in some conditions accept sub optimal returns to produce a ‘not so bright’ (your words) result. Nor do I seek the comfort of being warm and fuzzy, which albeit might be an acceptable result if being warm and fuzzy was indeed your goal.

No the reason I disagree with your ‘always go for the optimal investment’ answer is that I do not accept the underlying structure of the ‘risk line’ investment model I have just described to you. That model is flawed in this circumstance and that is why I keep coming back to the point that your conclusion is flawed in this circumstance. IMO you are using the wrong investment model to evaluate ENP’s situation. Your argument has merit for a non-specific goal investment strategy with longer timeframe. But IMO it is not applicable to the investment question that ENP posed.

SNOOPY

[Sauce]

Sauce, you perpetuate the myth that banks are just waiting to trick you into taking out as large a mortgage as possible so that when the market turns they can toss you out on the street and reclaim their cash in a mortgagee sale leaving you destitute and homeless. This is not a sustainable business model for banks. Banks do not enjoy doing this and do not plan to do this when taking on new mortgage clients. In fact they go to extreme lengths to make sure a mortgagee sale is not on any event horizon they can paint.

You cannot suggest that everyone who buys a property in a housing boom is financially destroyed. Whatever the market says about the value of you house, you are only financially destroyed if you can’t make your interest payments. Market valuations come and go. Acting on those capital market valuations is always optional.

SNOOPY

Hi Snoopy

Sigh. Shifting the debate to irrelevant detail again Snoopy, I think you understand full well what I was getting at But to spell it out:

I wasn't perpetuating some view about banks at all. I never said 'financially destroyed' I said 'financially destructive'.

Imagine you beat 6 other offers in a frenzy to buy a typical Wellington suburban 3 bedroom house during 2007 for $550k with 10% down (55k). Say an interest only loan at 7% for the rest. Rates, insurance, average annual maintenance and interest would be approximately $820pw or $42,650pa. Typical rent they would otherwise paying on a 3 bedroom suburban home in Wellington would be $23,400pa and comes with no maintenance costs. So your annual net cashflow (after taking off the rent you would pay for the same lifestyle if you didn't own it) is -19,250. Market tanks in 2008. You hold through a period of negative equity where you are stuck in the home because its impossible to move without wiping yourself out financially. No problem, its now in the bottom draw, your happy to stay in one place, its your home after all. Property always comes right. Ten years later 2017 rolls round. Property has indeed recovered, and has even risen way above its previous peak of 2007. You have now got two kids and its time to go. You put the house on the market and at a competitive auction or tender you get three bids and happily sell the property for $700,000, a tidy profit of $150,000 less $20,000 marketing and agents costs, for a net gain of $80,000. Lucky it all worked out right?

In total you paid $192,500 above the cost of renting the same home. You also put in capital of $55,000. For a total cost of $247,500. The equity realised from the sale was $135,000 for a total loss of -42,500 over ten years.

Now add the opportunity cost of what could have been done with that money over the ten year period (risk free bank deposits make a good proxy) and it looks even worse.

The point is that paying too much for a home matters. It matters a lot. And your financial future can be a hell of a lot better if you treat your first home as a financial asset.

Chasing up ANY asset can be financially destructive whether the bank takes it off you or not. You are right that banks do not work in the manner you suggest. But that was not what I meant. If you feel I implied that, then hopefully the above example provides an example of what I meant.

Don't forget, I am not saying this kind of example happens often, all the time, or is likely to happen to ENP. I am trying to explain that the thinking behind your 'hedge' idea exists from the same kind of emotional desire for home ownership regardless of financial considerations that leads to people making home purchasing mistakes like the example above. This is why I don't like it. Personally I have seen people who think like this make bad financial decisions.

Clearly its a subjective debate that is getting quite rediculous, but in general I think its bad advice for first home buyers. You are entitled to your view, and I accept that.

Cheers

Sauce

[Sauce]

Sauce there are certain so far undiscussed assumptions behind your ‘optimum investment savings’ strategy.

Don't forget, I was coming from the point of view of what ENP originally said: "in the big scheme of things it is to accumulate a house deposit faster" NOT your interpretation that achieving home ownership in two years was more important than the fiscal consideration.

As a conceptual point, I believe you are assuming that you can plot all of your potential investment strategies on a unidirectional line. The zero point on this line represents stuffing your cash in your pillowslip each week (no risk). Move slightly along the line and you get to the putting all of your money in bank term deposits strategy. Move further along the risk scale and you come to listed property trusts. Keep going and you arrive at listed companies, the riskiest investments.

No, wrong. I think the risk free rate is the benchmark. Once you head out from there, there are many variables that relate to riskiness, one of the largest being your level of understanding of your potential investment options.

And herein lies the point. If I buy contact shares because I have power bills, but I don't understand the investment, then I have a false sense of security: If it goes down, but I feel OK because my power bills might be lower, I am ignoring my opportunity cost. Even worse, if I use this thinking to purchase without understanding the business properly, I ignore the company risk, which is insanely risky and quite stupid. Its just not a clever way to think about investments.

Its more rational to think about each investment on its own merits and try and have a full understanding, if you don't, then don't invest. This is assuming you have chosen to invest directly in the first place, which for some people may be a mistake also - they would be better off in an index etc.

I should point out here that when I say risk, I am not referring to volatility. I am referring to the downside risk of losing the purchasing power of your capital.

We have the same definition of risk.

Now one point where you and I agree Sauce is that the skilled investor can assess individual company investment risk and by prudent selection deliver an overall return higher than just investing in an index of all companies.

Yes. I agree. And once someone has made the call that they are such a person, there is no need to cloud their thinking through such nonsense as their power bills as a reason to invest in Contact Energy, when it might be a poor investment.

For instance, take me for an example. If I convince myself that I should put the money I have in RYM in Contact Energy because I might have higher or lower power bills to pay in the future, is that a smart investment move? Indeed, is that a wise way to justify the investment? Surely you can see the absurdity in that?

If I understand RYM and I don't understand contact (which is the case for me personally) then it would be an investment mistake to purchase Contact over Ryman. It would increase my risk under our mutual definition.

If you tell me that I need to go out and learn Contact and its prospects, then you are simply saying the same thing as me anyway. That it needs to stack up as a growing investment in its own right to be considered. In which case I could then compare it to RYM, or others I understand, and make a call as to which one I deemed to be the better investment. If I liked them both on their merits I might choose to own both etc.

But IMO it is not applicable to the investment question that ENP posed.

When you look at the fact we both interpreted the goal completely differently its obvious why there were differing points of view. Under my interpretation your strategy makes it impossible for ENP to achieve his goal and is therefore wrong. Under your interpretation, I acknowledge your idea fits your interpretation of the goal, but in my personal opinion it is a poor way to think about purchasing an important financial asset.

Cheers

Sauce

[Snoopy]

Imagine you beat 6 other offers in a frenzy to buy a typical Wellington suburban 3 bedroom house during 2007 for $550k with 10% down (55k). Say an interest only loan at 7% for the rest. Rates, insurance, average annual maintenance and interest would be approximately $820pw or $42,650pa. Typical rent they would otherwise paying on a 3 bedroom suburban home in Wellington would be $23,400pa and comes with no maintenance costs. So your annual net cashflow (after taking off the rent you would pay for the same lifestyle if you didn't own it) is -19,250. Market tanks in 2008. You hold through a period of negative equity where you are stuck in the home because its impossible to move without wiping yourself out financially. No problem, its now in the bottom draw, your happy to stay in one place, its your home after all. Property always comes right. Ten years later 2017 rolls round. Property has indeed recovered, and has even risen way above its previous peak of 2007. You have now got two kids and its time to go. You put the house on the market and at a competitive auction or tender you get three bids and happily sell the property for $700,000, a tidy profit of $150,000 less $20,000 marketing and agents costs, for a net gain of $80,000. Lucky it all worked out right?

In total you paid $192,500 above the cost of renting the same home. You also put in capital of $55,000. For a total cost of $247,500. The equity realised from the sale was $135,000 for a total loss of -42,500 over ten years.

Now add the opportunity cost of what could have been done with that money over the ten year period (risk free bank deposits make a good proxy) and it looks even worse.

The point is that paying too much for a home matters. It matters a lot. And your financial future can be a hell of a lot better if you treat your first home as a financial asset.

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.

I won’t disagree with your numbers Sauce, but an interest only loan? Surely one of the purposes of getting a house is to build your equity otherwise, “what’s the point” as your example so clearly demonstrates.

By taking a mortgage you are also building trust with your bank that you can handle a loan. That means that when you want to borrow money at a later date, to buy shares for example, you can access that money at lower interest rates than those borrowing money to invest in shares directly (your renter). This will be a huge advantage to you later in life which you could not take advantage of if you just continued paying rent to a landlord.

Other times people buy houses to get into a certain school zone. Your analysis takes no account of reasoning like that. I presume you would dismiss ‘buying in a school zone’ as simply another warm fuzzy benefit?

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

[Snoopy]

And herein lies the point. If I buy Contact shares because I have power bills, but I don't understand the investment, then I have a false sense of security: If it goes down, but I feel OK because my power bills might be lower, I am ignoring my opportunity cost. Even worse, if I use this thinking to purchase without understanding the business properly, I ignore the company risk, which is insanely risky and quite stupid. Its just not a clever way to think about investments.

Sauce, I have never said that you should hedge with your investments without understanding what you are investing in. That would be stupid indeed, I agree. 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.

If I convince myself that I should put the money I have in RYM in Contact Energy because I might have higher or lower power bills to pay in the future, is that a smart investment move? Indeed, is that a wise way to justify the investment? Surely you can see the absurdity in that?

You should first determine that both your possible investments in Ryman and Contact are good underlying investments before proceeding. Using hedging investment thinking, I would regard an investment in Ryman as an investment in living space. Since everyone needs a space to live just as everyone needs power, it might make sense to transfer some of your investment in Ryman to an investment in energy, like Contact Energy, if you owned nothing in this sector.

The question you would put to me is:
“Can you make a case for Contact Energy as a better investment than Ryman, given that both are good?”

I would class myself as investment savvy enough to digest that annual report information that should enable me to answer this question. However, I cannot answer because I see the drivers of both shares as quite different.

I could say something like:
“If world energy prices go up and energy demand in New Zealand keeps going up then this will be beneficial to Contact with their renewable fixed cost generation base.”

I could say that:
“If Ryman can maintain the cost advantage of their in house construction team, they will be able to maintain better construction margins that will give them pricing flexibility unmatched by their competitors.”

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

[OldRider]

I concur with your last post Snoopy. Though one doesn't have to know everything to make a choice,
pick what is thought best at the time, always realising by tomorrow things may be different.
by next month they will be different. In fact we never remotely approach knowing everything
on any subject. It doesn't take much thought to realise I cannot compete stockwise with the
professionals and their budgets, but this still doesn't stop me from knowing something
they don't, and so seeing things differently. By far the best source of information is one's
own eyes and ears, talking to the staff of a company and looking at their hard assets.

It was once said that life is a journey from cocksure ignorance to thoughtful uncertainty,
only the young and the stupid know the answer for sure.

Life is not about getting evreything right, it's about handling what goes wrong when it
goes wrong, as it surely will sooner or later, and the sooner we see the difficulty and react
the better it will be.

[h2so4]

I concur with your last post Snoopy. Though one doesn't have to know everything to make a choice,
pick what is thought best at the time, always realising by tomorrow things may be different.
by next month they will be different. In fact we never remotely approach knowing everything
on any subject. It doesn't take much thought to realise I cannot compete stockwise with the
professionals and their budgets, but this still doesn't stop me from knowing something
they don't, and so seeing things differently. By far the best source of information is one's
own eyes and ears, talking to the staff of a company and looking at their hard assets.

It was once said that life is a journey from cocksure ignorance to thoughtful uncertainty,
only the young and the stupid know the answer for sure.

Life is not about getting evreything right, it's about handling what goes wrong when it
goes wrong, as it surely will sooner or later, and the sooner we see the difficulty and react
the better it will be.

Haha, love it.

Of coyrse we can be right evreytime. We don't even have to know evreything to be right iether. It comes from your perspective. ie the better it gets the better it gets or the worse it gets the worse it gets.

Am I young ignorant and stupid?

I hope so.