Investor Emotions

It is no wonder that investing can become so emotional. The traditional New Zealand investor most likely started off by buying a second house, often using some of the equity from their primary residence. This worked well, primarily because the taxation system was so advantageous to them. New Zealand has had a capital gains tax regime in place for years, yet for some perverse reason the powers that be made little use of it. At one stage when property prices in areas like Queenstown were going through the roof, there was increased IRD vigilance in this area. Off course this fell by the wayside when the finance market dried up and property prices in areas like Queenstown plummeted. There is now some unease amongst property investors, with Labour announcing a proposed Capital Gains tax, and mumblings about the tax breaks that many holiday houses provide to their owners.

The traditional fixed interest investor who invariably invested in fixed term investments offering significantly higher returns and risks than bank deposits is possibly at an investor low. Many lost significant capital in the finance company meltdown. Now with low interest rates prevailing they have difficult choices to make. Either reduce their standard of living because of the reduced earning from their investments, or consume capital to maintain their standard of living. No one really likes to reduce their standard of living. However for many investors except the extremely wealthy, sooner or later this will have to become a reality. This is because the real rate of return for fixed rate investments is below the rate of inflation. Combine this with consuming capital to augment investment returns, and the spending power of their investments is being rapidly eroded.

One of the closer investments to traditional deposits is bonds. These provide a fixed rate of return (the coupon or interest rate), however the market value of the bond fluctuates both up and down with the market supply and demand. Over the past few weeks, high quality bonds such as government bonds (forget about the ones in the debt ridden countries such as Greece) have seen their yield decrease (as the market value increases) as there has been large amounts of money go into high quality bond funds in the United States. However it has not been as rosy for corporate bonds. Corporate bonds tend to be the ones that Mum and Dad investors buy in new offerings. They may be unrated, however the coupon rate is attractive to these people. Unfortunately the coupon rate is often too low for professional investors to be seriously interested in them. The result can be an illiquid secondary market, with the market value falling well below the face value of the investment.

Currently, with historically low interest rates prevailing, there is really only one way for interest rates to go and that is to increase. If in fact they decrease, we have a major problem as the developed world would be in a prolonged recession. A period of increasing interest rates is not good for bond investors, as bonds will decrease in market value. There are strategies available to mitigate the impact of this. Hard decisions may be required for the health of your investments. Emotionally, it can be a bit like being on a roller coaster.

Disclaimer

Steven Barton (FSP 32663) and Susan Pascoe Barton (FSP 32382) are Certified Financial Planners and Authorised Financial Advisers.  Their initial disclosure statements are available free of charge by contacting them on (07) 3060080 or they can be downloaded from www.pascoebarton.co.nz. This column is general in nature and should not be regarded as personalised investment advice.