A client plans to buy a house in three years time. He has a sum of money ear-marked for the deposit, but at the moment it is all in equities. The recent turbulence has made him nervous and he is wondering whether three years is too short a time period for equity investment, yet wants to ensure he maximises his deposit. What options are open to him?
Mark Dampier Hargreaves Lansdown
I think it would be nuts for the client to keep all his money in equities for a property purchase. In fact, I wouldn't be in equities at all. The past three years have been brilliant and there are no guarantees the next few will see similar returns. I would even be nervous about using equities over five years. It is just a gamble that stockmarkets are going to be OK and the money won't be secure. If a client bought three weeks ago, he is already 10% down. That's not going to do much for his general well-being.
If the client is willing to take some risk of a capital decline, he could use something like the Insight Diversified Target Return fund or a cautious managed fund like that of Alistair Mundy at Investec. I would use two or three of them and they could still go down - even the Insight fund has dropped 3%-4% in the recent market rout. But you would have to hope that the upside was better than cash.
Other things to consider might be a guaranteed equity bond, so at least you know that you will get your cash back. This could be linked to the FTSE. Alternatively, some companies offer a unitised product linked to the performance of property indices like those of the Halifax or Nationwide. This would give a sort of option on the future price of a house.
Even if the client already had a property to fund part of the deposit, I would still be nervous about using equities. No-one knows how much property prices are likely to go up and you need to preserve as much capital as you can. It is also my experience that people tend to buy a more expensive property than they originally intended. There is always an extension or re-wiring to be done. It is always more expensive than planned.
Part of the trouble with this type of problem for advisers is that it has litigation written all over it. If an equity purchase went wrong, a client could legitimately complain to the FSA, who would ask why the adviser had recommended anything other than cash. Equities always run the risk of having three years of failure.
True investment is long term - you never want to be in the position where you have to pull your money out at the wrong time. Clients are easily persuaded away from putting money in the building society, but any self-respecting broker should be recommending cash
Max King manager, Investec Mgd Growth
The answer is simple. Investing the lot in equities for three years is fine. After two-and-a-half years (or earlier, if the funds have done well and the market is looking expensive), it might be worth starting to exit the holdings, rather than do it all at once after the three years. Remember that a plan to move in three years time is not a fixed liability, just an intention with uncertain cost. An adviser would probably suggest some combination of equities, bonds and property funds though investing in equities should achieve an excellent return - I anticipate 50% over the next three years - which would finance a nicer house.
Richard Philbin head, F&C Multimanager team
There are a lot of variables in this question. First of all, the adviser would have to look at the sum of money in each of the individual equity funds. He would also have to look at the level of education of the client and how long he'd been invested. If he'd been invested six months, he'd be happy. But there may be a difference if he'd been invested five years versus six years, for example. He might just be trying to get back his original investment.
Also, you have to look at the size of the deposit versus the value of the house. What does it mean to this client? If it goes up, will he be mortgage-free? Is it half the value of the house? This all has an impact on the amount of volatility he can accept from his investment. If it is £250,000 on a £500,000 house, that's very significant. If it's £40,000 on a £500,000 house and it drops to £20,000, that's not so significant. Clearly, it also depends on the degree of sophistication of the client. Is he prepared for a more nerve-wracking ride if he stays in equities?
Also, it depends on the type of equity. Three years is probably too short for emerging markets equity or Japan, but is it too short for equity income? Any equity market is higher risk, but there are degrees of higher risk. If you look at rolling three-year data for the UK Equity Income sector over the past 20 years - as illustrated by the graphs to the right- you can see that of 240 time periods, 30 have been negative. This equates to an 87.5% chance that an investor will get their money back. The most it has ever dropped in a three year period is 23.84%. The most it has risen is 216.61%. Bear in mind that this is the whole sector and includes a lot of bad funds. Looked at baldly, for taking 12.5% of risk, you could have tripled your return. As can be seen from the tables, the UK All Companies sector gives similar data.
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