NZ Herald 18 March 2023

AIt sounds as if you’ve been hearing a tired old story. There’s nothing dead about having equity in your house — the difference between the value of the house and your mortgage.

Your equity is giving you a home. Nobody can move you out or tell you how to run things. What’s more, you know that by the time you retire you will have most of your accommodation costs taken care of. That’s a big deal. There will of course still be insurance, rates and maintenance costs, but they will probably total a lot less than renters and people with mortgages have to pay.

Having equity in your house also gives you a sort of emergency fund. If the need arises, you could borrow against it for, say, a medical expense, a big maintenance cost or a family crisis.

If you borrow against the equity to invest in rental property, you lose that buffer. Still, it’s not necessarily a bad move. Many people do it, and quite a lot do well out of the venture. But some don’t.

An important rule when you invest in anything is: never put yourself in a position where you’re forced to sell.

In the next few years I expect some landlords, facing rapidly rising mortgage payments, and with rental income not nearly covering costs, will find themselves having to sell. And those who bought not long ago might have to sell for less than their mortgage. They have a debt to the bank and nothing to show for it. Gulp!

“Okay”, you might say, “but I will be buying in a lower-priced market.” That’s true, but house prices could well drop considerably more.

Perhaps we should add another investment rule: whenever you buy any asset whose price is volatile — such as shares or property or collectibles — picture the price falling in the next few years. Will that be difficult for you either financially or psychologically? If yes, don’t buy. You’re “very risk averse”, so this would definitely apply to you.

Also, don’t overlook all the hassles that can arise for landlords: troublesome tenants, rent not coming in, unexpected maintenance bills and so on. Do you need that in your life?

When somebody tells you that equity in your house is dead money, think about their motives. It might be a friend skilful and lucky enough to have done well with investment property. They mean well, but you won’t necessarily be able to copy them.

Then there are those who, one way or another, will gain from your buying a rental property. They might be real estate agents, property managers, or people who run seminars or advice services who clip the ticket when you buy a property. They might well get richer from your investment than you do.

You’ve done really well financially. I suggest you relax and enjoy your home and your island paradise. It sounds as if you could afford a few toys, even if it means becoming mortgage-free a year or two later. But before you splash out too much, have a look at the toy owners. Are their lives really happier than yours?

By the way, it’s great to know my book “Get Rich Slow” helped you. I still stand by what’s in it, but it was published in 2006, before KiwiSaver. My more recent books work better for readers these days.

AIt’s a sad story. Silicon Valley Bank prospered when tech and healthcare companies boomed during the Covid pandemic, and many of those companies put money into the bank.

The bank then invested fairly heavily in long-term US Treasury bonds. As you say, they are rock solid. There is practically no chance the US government won’t repay the money when the bonds mature.

However, since the bonds were purchased, the tech sector’s fortunes have declined, and the bank’s customers started to withdraw money at an unexpected pace.

To give them their money, the bank had to sell some of its bonds. The trouble was, interest rates had risen fast since those bonds were issued at the old lower rates.

Consider this: If someone offered to sell you a $10,000 government bond that was paying, say, 2 per cent interest, when you could buy newer ones paying 4 per cent, you wouldn’t be interested. But if you could buy the bond at, say, $8,000, knowing you would get back the full $10,000 when it matured, you might well buy. The lower price would make up for the low interest in the meantime.

That’s how perfectly safe bonds lose value when interest rates rise. If they will mature soon, their value drops less, because the buyer will get the face value back soon. But if maturity is years away, their value can drop a long way.

Conversely, when interest rates fall, older bonds at what have become higher-than-market rates gain in value.

Back to Silicon Valley Bank. When it announced that it had had to sell some of its bonds at a loss, that spooked the banks’ customers, and more and more decided to withdraw their money, in what became a classic run on the bank.

It seems clear the bank shouldn’t have bought so many long-term bonds. But perhaps its biggest mistake was that it broke another investment rule: diversify. Too many of its customers were in one or two volatile industries.

AFirstly, the New Zealand Reserve Bank has said our banks are not in a similar situation to the Silicon Valley one. “We are confident that the banks we are responsible for supervising have sound liquidity and funding positions,” it says.

Still, the news from America could get some readers worried about what would happen if their bank failed.

Currently, under what’s called Open Bank Resolution (OBR), if a bank fails, a portion of all accounts — including term deposits — would be frozen. You would probably get some of your money back after things settle down, but maybe not all of it.

In the meantime, the bank would stay open, and a small amount in each transaction account would not be frozen, so everyone could continue their day-to-day banking.

But what if your money was in a bank PIE, or portfolio investment entity?

PIEs, which include almost all KiwiSaver funds, are run by fund managers including banks. The PIEs you are talking about are either:

• Bank term PIEs, which have a fixed term and fixed interest rate, just like term deposits, or
• Bank cash PIEs, where you can deposit and withdraw when you want to, and the interest fluctuates.

All PIEs, whether or not they are run by banks, are not subject to OBR, says a Reserve Bank spokesperson. However, PIEs invest in financial instruments, and many of these types of PIEs invest only in interest-bearing deposits with their own bank. Those deposits would be affected by OBR if the bank failed.

A better choice, if you want to reduce the OBR risk, would be a cash fund that invests in a range of deposits with different banks and perhaps other entities. There’s info on these types of cash funds, including what they invest in, in the Smart Investor tool on sorted.org.nz. Go to Compare, Managed Funds, and then Defensive.

Note, though, that worries about bank failure should diminish soon, when the government guarantee of bank deposits up to $100,000 takes effect.

“The Bill will be passed this year and will be operating next year,” says a spokesperson for Finance Minister Grant Robertson. He couldn’t be more specific about when next year.

AThanks for writing, and for the endorsement of laddering.

AGood idea. Firstly, check what other banks offer in the Saving section of interest.co.nz. If your bank is lagging, point that out to them. Even if your bank is a leader, you still might be able to do even better by asking.

ASorry if that Q&A upset you. However:

• The reader had apparently misunderstood laddering, and I wanted to air his thoughts and clear them up — especially as other readers might also have misunderstood.
• I nearly always run critical letters. I suppose it’s a matter of pride. I don’t like the idea of someone thinking I didn’t have the courage to publish what they say. And sometimes I have to acknowledge they are right — although not last week!
• Unlike comment sections, people who write to me give their names, email addresses and phone numbers. That tends to keep comments more civilised.
• There are only a few letters like that each year.

One more thing: You’ve made assumptions about the reader’s gender and age. He does indeed have a usually male name, but who knows how old he is? But let’s not have crabby letters from boomers complaining about your unfairness!

More on laddering term deposits next week.