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This email I recently received is from a client who has just received an inheritance.
Hi Dean,
Can we have a chat about Auntie's money sometime, please? I now have $10,000 sitting in my bank account and want to invest, but I'm not sure where. My brother suggested a term deposit might be a good option as the interest rate is high. However, I have always been interested in trying managed funds, but I am nervous about the risk. I'm not sure what to do. Thanks for your help.
As a financial planner, this is one of the common investment questions I am asked.
The frustrating thing for people is that there is no easy answer, as it very much depends on your financial situation and whether you have any high-interest debt, a mortgage, and cash reserves. It also depends on what the money is for and when you need the money.
Going into detail about this can be a bit dry. Many of my clients are mountain bikers and sports enthusiasts. So, I decided to answer the above question using a more exciting story. Read on.
I will attempt to put it into context with a recent adventure I went on with a friend.
For years, I had aspired to mountain bike The Paparoa Track, a 55.7 km shared hiking and mountain biking track located in Paparoa National Park in the South Island. The track was created as a memorial for the 29 miners who lost their lives in the Pike River Mine disaster.
Every time my friend and I tried to book the popular Moonlight Tops Hut on the trail, it was already booked.
An acquaintance said the local shuttle driver suggested an alternative - doing the short ride to Ces Clark Hut on the first day and completing the rest of the trail the following day. At the outset, this seemed like a great plan. I had been training for 50km rides already, so 49km on the second day seemed easy.
We took his advice, and with much enthusiasm, we jumped online and booked Ces Clark Hut, the ferry, accommodation, and the shuttle to the trailhead.
We continued training, our bodies were ready, and we prepared for what we needed in terms of gear and food.
We were good to go.
The only question mark was the weather, and on Monday of the big week, the weather forecast was not looking good. The hut, accommodation, and shuttle were non-refundable; however, our stubborn determination meant there was no backing out. We bought extra riding gear as a backup.
Day one was a beautiful, sunny winter's day. The 10.3kms consisted of a steady Grade 4 climb and had our legs burning. We reached Ces Clark Hut in 2 hours 14 minutes. Now we started to question whether having such a short first day was a good idea, knowing there was a long way to go tomorrow and much climbing still to do.
We enjoyed a relaxed afternoon and evening in the hut. As the day drew to a close, the hut filled up with weary hikers and bikers alike. The forecast for the next day looked grim. We got an early night and planned to be up and on the trail by 7:00 am.
I woke up the next morning feeling extremely unwell, with low energy and a dodgy stomach.
We decided to head off early and stop at the next hut for breakfast, yet I wasn't in the mood to eat. The weather had turned to gale-force wind and driving rain. The exposed mountain ridges were becoming a real challenge.
We dug deep and made it to the next hut. I forced myself to eat porridge, and we huddled around the fire to warm up and dry our gear. It was decision time: do we continue? Or do we call it a day and stay in the hut?
We decided to push on. We were both confident we could make it out (it was only another 36kms, and surely that would be downhill eventually).
Keeping warm was the priority. The uphill riding helped, but a long stop to fix a puncture meant we cooled off very quickly, and this is where my doubt about whether we could make it out crept in.
Despite the bitter cold and the illness, I was determined not to be airlifted off this track.
After 7 hours on the trails, we made it out, elated and exhausted. I had never had to dig deeper on a mountain bike. I had underestimated what this adventure entailed and had not thought through the risks of doing it in winter.
There is a moral to this story, of course.
We could have planned an easier track to ride on King's Birthday weekend. For example, The Timber Trail. Generally suited for all types of riders, this is a fun track of 85km in total with one long climb and some fairly fast descents.
To me, the Timber Trail is a bit like a Term Deposit, i.e., low risk and low reward. It is well worth doing, but do not expect the adrenaline return you will get from a grade 4 to 5 mountain bike adventure.
A term deposit offers a fixed interest rate over a specific period, typically ranging from a few months to several years. Your initial investment is generally secure, and you'll receive it back, along with the interest earned, at the end of the term. No frills and low risk, a term deposit is considered low risk because they are typically backed by government guarantees or deposit insurance.
The interest rates may be lower compared to other investments, and you may not be able to access your funds before the term ends without incurring penalties or forfeiting some interest.
Planning for the best, current 5-year fixed interest rates are around 5.16%. Many may see this as a great return and be eager to lock their money away for 5 years.
$10,000 over 5 years in a term deposit will earn you $2,938 in interest (exclusive of tax).
Prepare for the worst. In the last 5 years, inflation has gone from 1.5% to 6.7%. Forecasters predict high inflation to continue for some time into the future.
If you are earning 5.16% before tax and inflation is 6.7%, are you winning? Is the reward worth the effort of tying your money up for 5 years to be rewarded with $1,886 for your effort?
The Paparoa Track is a challenging grade 4 ride with long, tough climbs with loose rocks (shist). You work hard for the descents, but for more experienced riders, the effort is worth it. The descents comprise narrow exposed sections where, if you clip a handlebar and fall the wrong way, you won't stop falling for some time. Tight switchback corners, steep fast sections punctuated with streams, culverts, and dislodged rocks to dodge. Then, you are rewarded with some long serious fast descents, bermed corners to rail, and with the wet conditions at times, it was like riding down a flowing stream at close to 20km per hour.
I would consider the Paparoa Track to be more like investing in a managed fund. The risks are higher, but the returns are well worth it. Managed funds are a good option for those who understand the risk, have some reserves in the tank (cash in the bank), and the fortitude to stay the distance (not panicking and withdrawing at the wrong time).
Managed funds are overseen by professional fund managers who make investment decisions on your behalf. Diversification is key, spreading the risk across different investments and other securities. Investing in thousands of companies across multiple jurisdictions (countries), investing in emerging markets, and developed markets is a widely diversified fund that spreads the risk.
Most New Zealanders have a managed fund already through KiwiSaver, except your money will be locked in until you qualify for NZ Super (currently 65), with a few exceptions, including first home withdrawals, hardship, or terminal illness.
When it comes to investing, I advise my clients to focus on the long term. The best way to get your money working hard for you is investing long-term in the markets. History has shown us that equities (stocks) have outperformed any other asset class for as long as we have data to prove (1928 in the case of the S&P 500).
Investing in an aggressive portfolio over a 5-year period could potentially yield you a very good return. However, markets are volatile, and a 5-year time frame is short in terms of investing.
$10,000 invested in the S&P 500 in 2018 for a 5-year period could have returned you $6,850 in interest before tax and fees. This would have kept you ahead of inflation and in a better position to extend that out over 20–30 years. Surely, that is a better place to invest your money?
Calculating the return after tax and fees is not a straightforward process. It will depend on the type of portfolio and your income. However, the top PIR (Prescribed Investor Rate) is 28%. This is where advice comes in. There are many platforms where you can invest directly if you have the time and inclination.
Back to my lesson on King's Birthday weekend and the moral of this story.
We began our adventure optimistically. We had visions of riding amazing trails, seeing beautiful scenery, and having time to catch up. In planning the trip, I relied on hearsay and didn't do the research I should have done. Yes, we made it through, and yes, it was an adventure we will remember. But it would have been a better outcome (more enjoyable and less stressful) if I had sought good advice on when to ride, which hut to ride to on the first day, and what the terrain is really like.
We ended our adventure thankful we had the appropriate clothing, gear, and ability to complete the ride. Seeking advice, having a plan, and knowing what to expect (getting advice) would have been the smarter approach.
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And making decisions based on that advice can lead to more downs than ups....
Whether or not you should invest your $10,000 in savings in a term deposit or a managed fund depends on the goal, your time frame, and many other aspects of your financial situation. I would suggest a financial planning approach is better than just having a crack, as we did with the Paparoa Track. You are likely to have a much better time of it if you plan well and take solid (not hearsay!) advice.
Banking on a good ride? Do your homework and get some good advice.
Dean.
About Dean:
Hi everyone! My name is Dean, and I am a Financial Adviser and coach. I work with people to help them to achieve their financial goals and assist them to make smarter financial decisions. Drop me a line for a chat and to work through your goals. I work with you to become financially fit and together we create a game plan for your financial future. D.
Disclaimer: Dean Blair (FSP87402) is a Financial Adviser with Velocity Financial(FSP95466). No investment decision should be taken based on the information inthis blog alone. Please see Dean’s disclosure statement on our website.