The Key Elements of Financial Planning

Diversification, security and an adequate return for the risk being taken are key elements

Significant financial events can influence more than the profitability of individual businesses. They can alter the investment attitudes of a generation. The Depression was such an event. In New Zealand the share market collapse of 1987 significantly affected investment attitudes. This decade, and more particularly the last two years, is likely to create a similar outcome.

Where to from here for investment?

That impact is not evenly spread however. Investment into shares will take time to bounce back. Property less so. And despite the failure, freezing or closure of numerous income based organisations such as finance companies and mortgage funds, enthusiasm for the latest good rate appears undiminished. Or at least that conclusion could be intuited from the enthusiasm shown in recent months for company fund raising. Recent issues include Auckland Airport, Fonterra, NZ Post, Tower, Contact Energy and AMP.

Corporate Bonds appear to be an attractive investment currently

This form of debt is generally known as a Corporate Bond (higher security) or a Capital Note (lesser security). The rationale is that the company needs to raise funds. Since the world wide credit crisis began in September 2007, it has become increasingly difficult for New Zealand companies to borrow offshore. The international market is not as keen as it was to lend to small companies on the other side of the world.

When an investor purchases a Bond or a Note they are providing a loan to a company. In exchange for the loan, the company promises to pay interest (called a ‘coupon’) to the investor over the life of the investment. The company will pay either a fixed interest rate (for example, Contact Energy’s recent offer of 7.75%) or a variable interest rate, which is usually pegged to cash rates. In the case of a variable rate, if interest rates rise the company will pay a higher rate of interest and vice versa if they fall (a recent example being Westpac’s government-guaranteed floating rate bond, which returns 0.6% over cash rates). Fixed coupon bonds are more popular with retail investors because they create the illusion of security. But just because the company is a household name and offers a fixed return does not make it a safe investment. Household names do strike trouble from time to time.

Are all bonds created equal?

It has been said that the ability of a company to honour its promise of income should be measured under conditions of depression and not of prosperity. It is also necessary to understand that they are not all created equal. In purchasing this investment we should want to be as high up the security ladder as we can. Unfortunately that space is generally already taken by the bank. That Capital Notes differ in security terms to Corporate Bonds is not readily understood by consumers. Some recent Capital Note issues include Fletcher Building, Infratil and Sky City.

Diversification, security and an adequate return for risk taken

Whether times are good or bad the basics of diversification, security and an adequate return for the risk being taken are key. But in income investing those rules are often ignored. One of the worlds’ great investors Benjamin Graham wrote: “It appears to be a financial axiom that whenever there is money to invest, it is invested; and if the owner cannot find a good security yielding a fair return, he will invariably buy a poor one. A prudent and intelligent investor should be able to avoid this temptation, and reconcile himself to accepting an unattractive yield from the best bonds, in preference to risking his principal in second-grade issues for the sake of a larger coupon return.” Food for thought.

Stephen McFarlane is a Chartered Accountant and Certified Financial Planner. He is an adviser with the One to One Group and Triplejump both of whom are based in Timaru. A Disclosure Statement is available on request and free of charge at www.one-to-one.co.nz.

Frugal Living – are you a Frugal McDougall or Lavish McTavish?

Frugal living. It may simply be the times we live in but the term has been appearing in my reading recently. This week I found it in Time magazine in an article on American Julia Scott and her website www.wisebread.com (subtitled living large on a small budget). So I went looking. As promised there were a variety of ideas to save my dollars. This included the six steps for avoiding impulse buying when at the supermarket, bargain hunting for construction materials, an overview of three types of savings goals, penalty charges at the bank and many more. I found the website interesting rather than useful but it did get me thinking.

It makes sense that we should wish to arrange our spending to maintain our required standard of living at the least cost. That’s simply being efficient with our money. And it’s no different from other spheres of our lives. We are entitled to arrange our affairs to minimise the amount of tax we have to pay, as long as we stay within the law. It is a mainstay of an investment plan that we should seek to minimise the risk taken for the targeted return. This is no different – although I can imagine my wife groaning at my having found a justification for frugality in our day to day living. Frugality in this sense is defined as being organised, knowing what the plan is and sticking to it. It doesn’t mean to suggest a lower standard of living. Choice should remain as to how we spend our dollars. The key issue is to be efficient in how we spend. To get the biggest bang for the buck so to speak.

Be efficient in how you spend

My references points for frugality had been overseas sources to date and so I was interested to Google New Zealand sources. There were various options including more hints for surviving the supermarket. But it was www.guide2.co.nz/frugal-living and a post from Ruth Brown which caught my eye in supporting the proposition that being considered in our expenditure can lead to better, not lesser outcomes.

Are you more like Frugal McDougall or Lavish McTavish?

There were two clans – the McDougalls and the McTavishs. Lavish McTavish never gave much thought to tomorrow. He wanted to give his family whatever they wanted. And if he didn’t have his own money, he’d use someone else’s – often borrowing from his generous neighbour Jack McBank. At night, you could pick Lavish’s house a mile away – it always had the lights blazing in every room. At the other end of town, lived Frugal McDougall – not much to his name, except a modest income and a plan – to take his family to see the world. Frugal knew exactly how much it would cost and how long it would take him to save it.   He also knew how he would achieve it – with his family’s help and just a few dollars at a time.  So when no one was in a room the lights were off, appliances were turned off at the wall.   They knew what was in the pantry and the freezer and they planned their meals around it.  They bought in bulk where they could and waited for specials.  They grew their own vegetables.  They made their own cleaning products from simple household ingredients.  Whenever anyone got a fifty cent piece, they would put it into a special jar.  Whenever they thought they’d like to buy something, they waited 24 hours to see if the urge wore off. Finally, in fact, much sooner than they expected – Frugal McDougall and his clan with a plan, were off to see the world. Unfortunately, at the other end of town, Jack McBank got sick of Lavish McTavish borrowing money and not paying it back and sued his kilt off and took his house. Frugal McDougall had by far the better outcomes.

Stephen McFarlane is a Chartered Accountant and Certified Financial Planner. He is an adviser with the One to One Group and Triplejump both of whom are based in Timaru. A Disclosure Statement is available on request and free of charge at www.one-to-one.co.nz.

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