The most common question I get asked as a Financial Adviser is “what should I invest in to get me the best returns”? The prospective client usually has something in mind already. You guessed it, property. Property is the most common asset kiwis invest in and everyone who owns property love to share their success.
I have learnt to play along. So, I usually reply with property! I follow it up with “Do you want to know why”? It’s because you can borrow money against your existing home (called leverage).
Let’s say that you can buy a rental property by putting down a $100,000 deposit and leveraging the rest against your home. You buy a $1,000,000 property.
After 1 year the $1,000,000 property has gone up to $1,100,000. That’s 10% gain on the property but a 100% gain on your initial $100,000 investment.
What happens if the property drops to $900,000 over a year? That’s a 10% loss on your property and a 100% loss on your initial investment of $100,000.
If you invested $1,000,000 into a share portfolio, in either of the above situations your gain or loss would be limited to 10% as there is no leverage involved.
In both cases, you only lose when you sell. So, it is better if you can hold the investment. There are some situations which mean you may have to sell. However, if you have leveraged your property and your costs (interest) becomes more than the rent you are receiving you may be forced to sell for cashflow reasons. You can’t hit pause on accumulating interest.
Investing in a portfolio of shares can either be set and forget (if it is managed) or you can contribute regularly but pause if you go through a tough time.
Investing is about risk and return. The greater the potential risk, the greater the potential return. Heavily leveraging your investment provides the highest risk of loss.
I wanted to book mark this point in time.
Why? When I run through the above risks with clients, especially those that have already made their mind up and are just seeking validation, their response is quite often “but things are different this time”.
The reasons why a particular market ends up in a negative situation are always different. History tells us that it happens and will likely happen again. That’s normal. Always going up is not.
So, what should you focus on? Your goals. Think about what you want in retirement. You may not need to leverage property. If you do, put a plan in place for how you get through a time like this. That will typically involve investing across different assets like cash and shares.
From Independent Economist Tony Alexander
Investors not following young buyers
Last month I wrote about the results in my monthly survey of mortgage advisors showing that first home buyers are returning to the market. My latest survey of brokers shows that this flow of young buyers has become stronger and we can also now see this upturn in my monthly survey of real estate agents.
Are investors yet following first home buyers back into the market? No. The coming start of a new financial year will see a further reduction in the proportion of interest expenses which investors can deduct against rental income for taxation purposes. This is acting as a disincentive to new buyers although as noted here repeatedly over the past couple of years there remains no evidence of any wave of investors selling.
Having said that, there have been one or two articles in the media noting young people buying properties as an investment. There is a small return of what was known as rent-vesting. In an election year with considerable uncertainty about the state of the economy and potential changes in taxation policies it isn’t likely that investors will return in any great volume before the middle of October.
In fact, for investors to return we’re probably going to need to see interest rates on a downward track. There have certainly been some good specials offered in recent weeks by banks concerned about losing market share in an environment where real estate turnover is the lowest in three decades.
But there is no generalised downward trend in fixed mortgage rates in place just as yet and there may not be before the middle of this year. Considerable uncertainty remains about inflation here and overseas and it’s probably going to be quite some time before central banks indicate they are confident that inflation is heading back towards 2%.
For now, for most people, fixing either one or two years is likely to be optimal. But keep an eye out for the special deals being offered now and then by the main lenders. Who knows? Maybe one of them will offer an attractive long term interest rate. But don’t expect a return of the 2.99% five year fixed rate seen over 2020-2021!
For additional information on the economy, housing market, and interest rates, you can subscribe to Tony’s free weekly Tony’s View publication at www.tonyalexander.nz
Disclaimer: This newsletter is meant to be informative and engaging, hopefully not a cure for insomnia. Please don’t take this as personalised financial advice. Discuss your situation with an Advisor. This is where I need to say past returns are no guarantee of future returns.