It doesn’t matter whether we’re advising someone with $10 thousand or $10 million – the principles are still the same: before you invest, make a plan, then make sure you understand what you are investing in and, lastly, always use your own judgement.

When making a plan, it helps to step back to see the big picture. To do this, divide your money into 3 categories – A, B and C. ‘A’ is for Everyday money that comes in regularly from work or pensions (not investment income). ‘B’ is Buffer, so you’re protected in emergencies and protected from short-term market fluctuations. And ‘I’ is Investment money - money you invest for the medium or longer term. It’s the Reserve money, which people don’t usually pay attention to, which makes the difference.

Everyday money - is it enough to live on or will you need regular top ups from the capital you’re about to invest? If so - then how much money do you need to take from your Reserves each year to make good the shortfall in your Everyday money? Don’t make any investment decisions until you’ve done this exercise.

Reserve money - you need money on call in the bank so that it is always available for emergencies. Murphy’s Law applies to Investing as much as it does to everything else – just when you need money for an emergency always seems to be the time when your investments have fallen in value. So make yourself immune to Murphy’s Law by keeping a sensible amount in your Reserves. I usually suggest to clients that their Reserve money should be a multiple of their income requirements – the way this is calculated depends on your individual circumstances.

Investment money - is what you have left. It’s this money you can now consider investing. Your Investments are best spread across different types of investments and, because the New Zealand economy is very small, and therefore more vulnerable, you should include different currencies and foreign investments in the mix, because sound investing = varied investing. The variety principle also applies to time – take your time and invest it gradually. This minimises the effect of market fluctuations. 

Lastly, a brief note about tax. Tax breaks are often over emphasised, which can lead to un-balanced choices. Better a good investment that pays some tax than a poor one that’s tax-free.

Once a year look at your Reserves and your Investments. If your Investments are up and your Reserves are down then use some of your profit to top up your Reserves to the planned level. But if your Investments are down then leave them where they are – there should be enough Reserves on deposit to get you through difficult times. Investments are for the medium to long term and are always going to fluctuate. That’s what the short term Reserve money is for – to allow your long term Investment money to fluctuate as it, hopefully, grows.

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Personal Stories

Jean turns capital into income

Jean had been widowed at 50. Her husband’s job had left her with quite a good pension as well as the insurance money, plus she had an inheritance from her parents, which came to a total of $300,000. Her job as a part-time school secretary didn’t pay that well and it was the first time she’d ever had to think about investing money. She knew she should be OK but was worried about how much of her capital she could spend. She didn’t want to run out of money and she wanted to help her two children a bit but she didn’t know if she could afford to. This is what we did.

Firstly we worked out how much she needed to live on – which came to about $50,000 a year. Her pension and earnings came to about $40,000 so she had an annual shortfall of $10,000. Her A money was $40,000 and she had a $10,000 shortfall.

Then we worked out what size Buffer she needed. Her shortfall was $10,000 per year so we decided it would be a good idea for her to keep 5 years shortfall in her bank savings account. That used up $50,000 of her money.

Finally we looked at her capital. She had $300,000 but I’d made her put $50,000 into her Buffer so now she had $250,000 left. She could have looked around for shares to invest in, but she needed to spread this money widely between different geographical areas and different currencies. We also didn’t want to invest it all at once. So we used a range of widely spread, managed funds. Each month for the next year we put just over $20,000 into these funds. So Jean got an average price over a whole year and thus minimized the chances of having all her money caught by any sudden market crash.

She takes no income from this Investment money – if she needs money during the year she takes it from her Buffer, which makes things much simpler. She only spends what she needs and it’s easy for her to keep a track on how much she’s spending.

That was about 15 years ago, and each year after, we followed the same plan. Once a year (actually we do this on her birthday) we look at the value of her Investments in these various funds. If there’s a profit (including any accumulated interest or dividends) we take enough to bring her Buffer back up to $50,000 and leave the extra profit invested. If the profit is higher than she needs (after allowing for inflation) then she takes out some extra and uses it to change her car, to go on a special holiday or to give to her children. If the Investments aren’t up in value then Jean simply leaves them alone and relies on her Buffer for another year. She can last for up to five years of poor investment returns without having to draw any capital. And Jean knows exactly where she stands.

Once the initial set-up has been done then everything else is easy. Jean has enough for herself, has some in reserve, with the remainder invested wisely and whenever she’s got any spare she spends it or gives it away.

Some 'what NOT to do' stories

Adam was an insurance client of mine who came to me one day asking me to invest $100,000 for him. He didn’t want any fancy plan, just a good return on his money. But I was sure he didn’t have that sort of money – he ran a petrol station and a car hire business and whilst he was doing OK, he couldn’t have had that sort of money lying around. And he didn’t. It wasn’t his money – it was the average amount of money that he collected from his forecourt which then sat, in his business account, until the petrol company collected it six weeks later. The interest rate he was getting from the bank was very low and he was sure he’d get a better return from shares - at that time world stock markets were rising fast. I pointed out that if they fell at all in the next six weeks then not only would he have gone out of business but he’d probably end up in jail. He seemed to think that it was possible to predict the stock market and sell shares before they fell! Anyway I sent him away with a flea in his ear – in fact I was so blunt that I lost him as a client but I did save him from wrecking his business and probably his life!

Then there was the client who didn’t want any advice from me because he was getting a 15% return on his government bonds. Admittedly this was a few years’ ago when interest rates were very high but this was still about 5% higher than elsewhere. It turns out they were Government of Mexico bonds and were denominated in pesos. He honestly didn’t understand the size of the risk he was taking.

I also had a very posh client from the UK who gave me the same story. His money was invested with a broker who was into UK Government Bonds and was getting him a rate of 2% above the normal rate. 2 years later the broker was in jail for fraud. He’d been ‘robbing Peter to pay Paul’ - the payments to existing clients had been coming from the capital that new clients had been investing – a classic pyramid scheme. Same old story – if something sounds too good to be true, it usually is.