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How to minimise risks when you are investing

This week on SmartMoney with NewstalkZB host Tim Beveridge, we talked about borrowing money to invest and whether it is a bad idea.  Intuitively you’ll know the answer I imagine.

The topic followed hot on the heals of Auckland City Council’s highly contested decision to sell some of its shares in Auckland Airport to avoid passing on hair raising increases to rate payers.
See NewstalkZB story June 10, 2023 for more. 

Two key points before I dive in:

1) I am not a financial advisor and do not provide personalised financial advise. I prefer to share information and the benefit of my knowledge after working in this space over 15 years.

2) It is important to distinguish between personal finances and government accounts.

Unlike Governments which can borrow cheaply and squeeze taxpayers tighter if they need to, in order to raise capital, most regular folk do not have that luxury.

For the purposes of what follows below,  and pretty much all content on this website, I’m referencing personal financial matters.

So…on the original question posed by Tim B; “Is it a bad idea to borrow money to invest in the share market?” my personal view, in a nutshell, is “Hell yeah.”

It’s a bad idea for a number of reasons which I will outline below:

  • Borrowing money today is expensive. Imagine you took out an advance on your credit card at 19% to take a punt on the share market. This is not what I would call investing. This would be speculating with durations that are way out of whack. Borrowed money needs quick repayment, unless you want to go broke. Shares, typically, take time to grow in value, unless you have extremely good timing, or insider information, which is illegal. You’re effectively borrowing money at a high rate of interest, that becomes incredibly expensive the longer you take to pay it back, hoping that your investment will pay off. You’d have to hope that it pays out more than what you are paying to borrowing money, WITH INTEREST, plus a decent return to cover your risk of a heart attack if it all goes wrong.  A sound investor invests with well considered time horizons, in line with their overall financial capability, with a good understanding of the risks they are taking.
  • Opportunity cost. Irrespective of the source of funds for your investment, it’s important to ask yourself about the opportunity cost. In other words, is there a potentially better use of the funds that may have an ever better return or pay off for you? Some examples of this may be: paying off your mortgage faster, developing skills or advancing your education levels so you could improve your income earning ability or work satisfaction levels.
  • What if it all goes wrong? It is always good to run an exercise in your mind, and on paper too, to look at the consequences of things not going accordingly to plan. For example, if your investment took a sharp drop in value beyond what you paid for it, but you’re under pressure to repay the money to borrowed, where will that leave you? Plenty of people learned this lesson the hard with buying crypto currency and the like during lock down, only to have their dodge coin turn south and their financial obligations amplify.

Where to begin?

The days of cheap and easy credit look to be fast fading. As interest rates rise, including the cost of living, it is important to consider your overall net position and intelligently assess your financial position and wellbeing ahead of investing in something you don’t understand.

If you have debt, figure out how much it is costing you and how you may get that money off your back faster.
If you’re already invested in KiwiSaver, and in full-time or paid part-time work, remember that you are already an investor. You’re making regular contributions into your account in line with the pay cycle at work. This is a good start.

If you’re debt-free, and still have a heavy mortgage, you may want to consider increasing the frequency of your payments or else making (penalty free lump sum repayments)* to reduce your debt.

If you’re saving for a house, and you have a KiwiSaver account, you may want to fast track your savings there by increasing your contribution levels.

Just be clear you’re invested in a fund that is well-suited to your time frame to buying a home. I’ve seen many disappointed investors see their balances fall by 10-30% right at the time they needed their money because they were in high-growth, high risk funds, trying to max out long-term projected returns.  As tempting as it may be to choose the fund that dangles that highest long-term return rate, you must understand that on some years, because of market vagaries and other external factors, it can go south. First time home savers need to adjust for this risk.

If you’re not saving for a first home, or carrying debt, and you’re keen to grow your wealth, then this is a good time to explore investment options outside of KiwiSaver. In the last five years, we’ve seen an explosion of choices and providers offering alternatives in terms of investment platforms.

A decade ago, or so, you needed a minimum of $25,000 to invest and you had to do it through a financial advisor or a broker. Those thresholds have all but disappeared, which has reduced the barriers to entry for investors.
That’s been great for would be investors with smaller wallets but it’s also be created hazardous conditions for those folks who don’t know much about investing and the risks.

Sure, you can invest with as little as $1 now on some platforms. Whether it makes sense to do so, is another matter!

Investing in line with your goals, your time horizons, your risk tolerance and financial ability will all help to minimise disappointments.

*Ahead of reducing debt on your mortgage, make sure you understand if there is a cost to doing so. On a floating rate mortgage this usually isn’t the case but fixed mortgages can lock you in with repayments made on a complex bank-biased formula.