Welcome to our Education series that aims to explain various investment concepts in a friendly, clear, and precise format.
At Raymond James, Fulham, we really enjoy picking investments, managing portfolios and helping clients obtain financial security and achieve their goals. We feel that investing, when done properly can provide individuals with passive income and capital growth (over the longer term). However, there are times when investing is not right for individuals and we feel it is important to highlight when this might be. We will always be upfront with clients and prospects. If we feel that they shouldn’t invest or should look at reducing their portfolio, then we will always tell them.
Debt
“One of the things you will find – which is interesting, and people don’t think of it enough – with most businesses and with most individuals, is life tends to snap you at your weakest link. The two biggest weak links in my experience; I’ve seen more people fail because of liquor and leverage – leverage being borrowed money” – Warren Buffett
While debt is often unavoidable (think mortgages), the presence of debt might mean that investing is not appropriate for your situation. Let us say that you have credit card debt and you have accumulated £15,000 on the card and you are paying 30% APR on this debt. If you pay £500 a month off and don’t accumulate any more debt, how much interest do you think you’ll pay?
- £3,464
- £7,592
- £9,883
All these figures are quite extortionate, but the answer is C. It will also take 4 years and 2 months for you to pay this off. There is no investment that any investment manager, hedge fund guru or financial influencer can suggest that will guarantee £9,883 from £15,000 in just over 4 years, and if they do, run for the hills.
You might think that earning cash would offset it, but we have to take into account tax. Let’s say you are a 40% taxpayer and have used up all your allowances. If you have £10,000 in cash earning 5%, this is £500 gross, but the tax man will take 40%, leaving you with £300.
If you have £10,000 in debt at 4%, you will pay £400 in interest. Even though your debt interest is lower than the return you receive on cash (5%), after we have taken into account tax, you will be £100 out of pocket. This simple example shows that even if you receive a higher interest rate on your cash, it does not guarantee outperforming debt.
Mortgages
This is linked to the above, and although not as cut and dry as credit card debt, we would still recommend that paying down any mortgage remains your priority.
Although long-term nominal returns from global stock markets since 1987 have averaged around 7.84%*, and mortgage rates are around 5-7% you may think that it would make sense to invest over paying down debt. However, there is no guarantee that equity markets achieve their long-term average, while you know for certain that you will pay your interest rate each year.
Requirements for money
If you know that you are going to spend £50,000 on a house refurb in 12 months’ time, it can be tempting to keep the money invested until you need it. However, we would recommend that you take action as soon as you know you will need a sizeable sum of money.
Let’s say you had booked your refurb in the summer of 2008 for work to start in July 2009 and were going to dip into a portfolio of £100,000 to pay for it. If you waited until July 2009 to pay for this, then your £100,000 portfolio could have turned into circa £50,000 and instead of taking 50% of the portfolio, you would have to liquidate the entire amount. **
However, if you had encashed 50% of the portfolio and held this in cash for a year, you would have been able to pay for the refurb and been left with £25,000 in the investment pot, thereby allowing it to recover in time.
Risk-averse individuals
Quite often we will have individuals come to us saying that they don’t feel comfortable enough to invest because they don’t understand it or they feel like investing is too similar to gambling.
We would never disregard these fears, but we would sit down and try and explain why investing can be for everyone, as long as their financial situation allows it. We might start off with a more cautious portfolio to ease the client into an investment mindset.
As such we do not feel that this is an instance where you shouldn’t invest, but because its often used as excuse not to, we thought we should address it.
If you would like to talk things through with someone, please don’t hesitate to get in touch.
* MSCI Factsheet – September 2023
**for any younger readers, please google Great Financial Crisis.
RISK WARNINGS: This blog is intended for information purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person. Your capital is at risk when investing.