This article was published on 21 January 2006. Some information may be out of date.

Q&As

  • Shares v term deposits — it depends how much time you have.
  • Short-of-cash millionaires should try to renegotiate their mortgage.
  • When is a 2% penalty not 2%?

QWe often see comments to the effect that shares carry a better return than term deposits, but I find that hard to believe.

Take for example, Vector shares, issued at $2.38, but soon after reached $3.37.

Assuming an initial purchase of $1,000 the issue value is $999.60. If sold in the first few days at $3.37, the value would be $1,415.40, with a profit of $415.80.

That is a 33.45 per cent profit after tax at 19.5 per cent, but excluding brokerage fees and loss of interest on the capital invested from the date the application cheque was presented.

Great, but having sold, one then has to find another stock to invest in. In the meantime there is your $1,000 probably sitting in a low interest account.

So how can share trading, with all the risks (inherent to minority shareholders) associated with shares, brokerage fees and loss of interest on principal sitting idle, beat a known return for a known length of time in a term deposit?

And, if share trading was so good (and Vector shares have fallen considerably since then) for managed funds, how come funds so engaged seem to be losing investor money hand over fist?

AI’m a bit confused.

You give an example of a share investment that gained more than 33 per cent in just a few days. Even if you left the money for the rest of the year in an account paying no interest, you would still come out way ahead of term deposits.

Still, as I think you’re saying, that kind of gain is rare. It’s not uncommon for newly issued shares to lose value, and most gain much less than Vector.

Share trading is indeed risky, and the fees and loss of interest certainly cut into profits. You would also probably have to pay tax on your gains. All in all, I don’t recommend it.

What I do recommend in the right circumstances, though, is buying a wide range of shares, or units in a low-cost share fund, and sticking with the investment for years.

Any share investment will fluctuate in value. If you’re after “a known return for a known length of time”, term deposits win hands down. But over the long term the average return on diversified shares will almost certainly be higher than on term deposits.

Some recent number crunching shows that, over a single year, you have about a 60 per cent chance of doing better in diversified shares than in term deposits. But that rises to 70 per cent over three years, and 95 per cent over ten years. If you invest for 20 years or more, you are virtually guaranteed to do better in shares than term deposits.

Logic supports this. Because shareholding is riskier, nobody would invest in shares if they didn’t, on average, receive higher returns.

Let’s say that, for a while, shares were offering lower returns than term deposits. Lots of people would want to sell their shares and few would want to buy.

That would push down share prices. And the cheaper you buy an investment, the higher the returns will be — everything else being equal. Shares would be restored to their high-risk/high-return position.

This is what happens all the time in the markets.

By the way, managed funds that invest in shares haven’t been losing money lately. Most have been doing pretty well.

QMy wife and I are in our late 50s and own a house in Auckland worth around $600,000 and a house in Pauanui worth around $500,000. Our total borrowings are $130,000.

My wife is in a good job, and I have a franchised cleaning business that is slowly growing, giving us a combined income of around $80,000-$90,000 which I would expect to grow considerably over the next year or two.

We have very little in the way of investments, maybe $20,000 to $25,000 and a small pension in the UK at age 65.

Our problem is that we are living from “hand to mouth”, and it is a struggle every month to meet our commitments.

My question to you is twofold. Should we:

  • Trade down on our Auckland house and release enough cash to clear our borrowings? (We are loathe to sell our Pauanui house because we get so much enjoyment and relaxation from it and also some income.) Or
  • Go against all my instincts and sell our Auckland house, invest the proceeds at 7 per cent-plus and rent a property for about what I am paying in interest at the moment?

I would appreciate your views.

AThis must be a new phenomenon, almost-millionaires who are finding it hard to make ends meet. But I’m sure you’re not the only ones. It’s lovely to have so much wealth in our houses, but it doesn’t feed us.

You’ve got a big unknown in your future — how much you will make from your business. In light of your optimism there, I reckon you shouldn’t make either of your suggested moves just yet.

Instead, how about seeing if you can free up some money by renegotiating your mortgage?

I don’t know how much you originally borrowed. But let’s say it was $300,000 some years ago. Payments on that, at say 8.5 per cent on a 25-year loan, would be $2416 a month.

If you got a brand new 25-year loan of $130,000, payments would be just $1047 a month.

You probably don’t want to take on a 25-year loan at this stage — and for all their eagerness to lend, the banks might not want you to either.

But if you explained that you expect your income to rise considerably, so you will be able to speed up the payments and get rid of the loan in much less time, they might accept that.

After all, you’ve got heaps of equity in your two houses. If things go wrong, you can always trade down then and pay off the loan in full.

If you want to be more moderate, go for a 15-year loan. At 8.5 per cent, payments would be $1280 a month — which would still free up lots of money for you to enjoy.

I should add that I don’t generally like the idea of people in their 50s extending their mortgages. It’s a time to be getting rid of debt. And any mortgage extension means you pay much more in total interest — money that could otherwise be funding your retirement.

In your case, though, you expect your income to grow lots. And you’re on the point of making quite a drastic move — both of your options are unappealing. Buying a bit of time to see how things turn out makes sense to me.

Good luck with the lenders. I will be interested to hear how they respond.

QThought you might be interested in the following email exchange. I don’t intend to follow the matter up any further, but it might serve to prevent others falling into the same semantic trap!

To UDC: Re: Registered Secured Debenture Stock Certificate No. XX. I would like to withdraw the total of this investment 5 months early (matures on 19 May 2006) for payment into my usual ANZ direct credit account. Please advise me as to the feasibility and cost of this.

From UDC: Thank you for your email…. To withdraw the investment early will incur 2 per cent penalty on the interest earned to date.

To UDC: I see you have charged a penalty of 2 on the percentage rate of interest applied to my investment, not 2 per cent on the interest earned to date as stated. In other words, you applied an interest rate of 5 per cent for approximately 7 months instead of 7 per cent which, even after a 2 per cent penalty charge, would have given me over $200 more in interest! Please check which is correct.

From UDC: Two per cent on the interest earned to date is 2 per cent of the interest rate, so if your interest rate is 7 per cent, your interest is worked out at 5 per cent. That is how we get the 2 per cent penalty interest, which is from the time the investment began to the date of the break. I hope that makes more sense.

To UDC: Guess what! There is a difference between the ‘interest earned’ and the ‘interest rate’. I suggest you quote to clients the ‘actual amount of their earned interest that would be lost as a penalty’ in future.

AYou’re quite right. You paid a much bigger penalty than you were told about, but I’m sure it was unintentional.

If interest drops from 7 per cent to 5 per cent, we should say it has dropped two percentage points — which is much more than 2 per cent. It’s actually nearly 29 per cent.

The trouble with using “percentage points” is that not everyone knows what that means. Our language doesn’t handle this one well.

In the end, I think your suggestion is best. UDC, and anyone else, should put the situation in dollars. Everyone understands those.

Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to [email protected] or click here. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.