When my friend John Kneppler and his wife Sue got divorced, she and their children stayed in their jointly owned house and he moved into a new, much smaller place. He lived alone at first, but then, a few years later, his new partner and her child moved in.
I never learned about the reason for the divorce, but neither did he. He just obeyed her wishes as he had always done.
What started to grate him over the years was how much he had to struggle with two mortgages at the time until both places were paid off. Sue had always categorically refused to sell the big house and to share the proceeds of what proved to be a marvellous real estate investment. Their London borough started to gentrify, and the value of the house tripled. One day John called me to tell me the happy news. Sue had finally agreed to sell the house. As always, he could not explain her sudden change of mind, but in the end, after having paid off both mortgages and having spent celebratory holidays on a pristine beach, his current account showed a plus of £300,000.
And now he wanted to know what to do with it. He needed investment advice. The bank where he kept his current account, one of the new ‘challenger banks’ scrambling for deposits, paid some interest – but 0.25 per cent did not look like a terrific savings plan to him. Neither did it to me. Accounting for inflation, which started to pick up again after the decision on Brexit, John’s pot of money started to melt at alarming speed.
The first thing I told him to look at were his bank overdrafts and credit card debts. The cost of such arrears would without exception exceed whatever he could hope to earn on any half-decent investment.
As it turned out, John was free of any debt. No credit cards, no overdraft, no mortgage, no alimony other than for his children. When I asked him for how long he intended to put the money away – for a year, for 10 years, for longer? – he was not sure. He had a decent medical insurance, saved regularly for his retirement and thought of putting his money in a similar investment fund. He was afraid of leaving the money lying idle in the bank, as he had already done for the last six months before he summoned his courage to call me. What should I tell him?
If he kept the bonds to maturity, rising interest rates would do no harm to him
John was not what one would call a sophisticated investor, someone who had learned to accept that it is risk which is financially rewarded – the higher the risk, the higher the reward, and that financial losses will happen, like it or not. Not because he was a simpleton, but because he could simply not afford to lose this money.
The degree of financial sophistication is mostly a degree of financial wealth. But even he understood that by leaving his money idle on his current account he was in fact crediting the bank with an amount far exceeding any governmental guarantee for small depositors. He was risking the family silver without any reward.
We established that he was willing to leave the money invested for a couple of years, maybe seven years, but not for much longer. He understood that any forced sale in times of need might incur financial losses potentially exceeding any returns made in the meantime. I advised against share investments. Shares have a proven long-term potential but do not qualify for a short-term investment when the markets are already flirting with all-time-highs. Share prices are not defined by a contractual obligation but a parameter of market esteem. This is not predictable enough in the short term.
What we came up with after long considerations were three sterling-denominated bonds with a remaining time to maturity suitable to his wishes. I explained that the biggest risk he faced was rising interest rates. Long-dated bonds which promise yields suitable for today will lose in value once interest rates start to rise. In the UK this will happen sooner rather than later, as the Governor of the Bank of England has already warned. In a forced sale, these losses will materialise.
We therefore decided to match the duration of the bonds to John’s investment horizon. If he kept the bonds to maturity, rising interest rates would do no harm to him. The company has to repay the capital written on the paper. It’s a contract, not market whimsy.
“What should I tell the bank?” he asked.
“Tell them to give you a sales list of UK bonds with a maturity between five and eight years, including energy companies, pharmaceuticals, communication companies and miners. They should all have a good financial future. And then you come back to me and we’ll talk it over.”
A week later John calls me up with a chuckle: “I made a very good investment decision. I bought both my two kids a new car, and gave each of them the down payment for their first mortgage. With the rest my girlfriend and I decided to refurbish our house.”
I was very proud of my friend John. Nobody could have decided better.
Andreas Weitzer is an independent journalist based in Malta. He reports on the economy, politics and finance.
Please send in any queries, concerns or ideas that you would like Andreas Weitzer to discuss in his fortnightly columnto: editor@timesofmalta.com – Subject: Personal Finance.