When is ‘a bird in the hand’ better?
They are two perplexing questions that arise every now and then. One might apply when you are offered money or are selling something. Should you accept a certain amount now or more later? The other might apply when you are buying something. Should you pay a certain amount now or more later?
Your answer should depend on several factors. Let’s look at them by way of a current example.
Investors in ING’s troubled Diversified Yield Fund will — if they approve a plan proposed by the company — have two options. One is to accept 60 cents a unit now. The other is to accept a guarantee of 83 cents in five years — and possibly more if the financial markets behave themselves.
By the way, investors in ING’s Regular Income Fund face a similar choice, but let’s concentrate on the Diversified Yield Fund, for simplicity.
If you had invested in that fund, a good first step is to go to www.sorted.org.nz to find out what interest rate you would have to earn over five years to grow 60 cents into 83 cents.
To do this, use the Lump Sum Calculator. Feed in the $0.60 to start with and adjust the end date to 2014, so you have a five-year span. Try the calculation first with the 2.5 per cent return already there. Your 60 cents grows to just 68 cents. Increase the return and, through trial and error, you find the 60 cents will grow to 83 cents at a return of 6.7 per cent.
An alternative is to use Excel or a sophisticated calculator.
What do the results mean? If you took the 60 cents now, you would need an investment that would earn more than 6.7 per cent a year — after fees and taxes — over the next five years for you to be better off than if you waited for the 83 cents in 2014.
In the current environment, the only chance of getting such a return is in a fairly risky investment — which, of course, might fail to deliver. What’s more, if you decide to wait for five years, you might end up with more than 83 cents. Waiting seems a good idea.
There are, though, some sound reasons to take the money now:
- You need it to spend.
- You would rather get the whole thing over and done with and move on.
- You don’t feel you can count on ING to deliver what it promises in five years. It’s the good old “bird in the hand” principle.
Each investor will have to weigh up the pros and cons.
How does all this apply if you are considering buying something, at a lower price now or a higher price later? Let’s say the prices are $1,000 now or $1,200 in two years.
Again use the Lump Sum Calculator. By trial and error, you find that if you don’t buy now, but instead invest the $1,000, you will need a return of about 9.5 per cent — after fees and taxes — for your money to grow to $1,200 in two years. That’s a tall order. It seems better to buy now.
In this sort of situation, though, I would add a warning. Salespeople often try to close deals by offering you a lower price if you commit quickly.
A good rule is to always say “No” to such tactics. Too many people have regretted decisions made under this kind of pressure.
In any case, it’s surprising how often the salesperson will still accept the lower price if you come back later, after you’ve had a chance to think about it.
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.