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Get the facts behind the big business and finance stories from around the world – and down your street, in The Money Programme.

The programme Supersave Me went through a list of different investment and speculative alternatives, from short-term savings products through shares and property to betting on the horses. It looked at different attitudes to investing at different stages in the ‘life course’, with younger savers more interested in setting money aside for a rainy day or a deposit on a house and older savers keen on having an income in retirement. It showed how most savers want to choose themselves, believing they have an edge in choosing cars, property, share or racehorses. And they were all aware that there is risk involved.

There are a number of simple ways in which you can get the risk return trade-off that suits you. Some people, say close to retirement, don’t want too much risk; others, younger, are looking for capital growth which only comes with risk attached. If you have a nest egg, or are saving monthly, just decide how much you can afford to lose. For example, with a £10,000 nest egg, would you be able to survive if it fell to £5,000? Or can you afford only to have it fall to £8,000, say? The smaller the fall you can afford, the less risk you can take on.

Lady holding a piggy bank
with dollar bills falling from the sky.
[image © copyright Photos.com

The stock market, for example, can, as we have seen, fall 40 to 50% in a single year, although that is a rare occurrence. So, decide up front, how much you can afford to lose. It’s likely that if you are in your fifities, you will have a higher minimum value on your nest egg than a thirty-something with years to go before retirement.

You also have to decide your time horizon. If you are investing for 10 or 20 years, and can afford to hang on to your investments, you shouldn’t worry about short term falls as, at some point in the future, prices will recover. That is true of property too, but the problem with property is that it tends to be a ‘leveraged’ investment. People tend to borrow to invest in property, so that a fall in the value of the property or in rents can mean that the loan is called in and substantial losses incurred. People tend not to borrow to buy shares so investing in shares is less risky than borrowing to invest in buy to let.

But the simplest way to make sure you maximise your expected return for a particular level of risk is to diversify across different kinds of assets. Put simply, don’t put all your eggs in one basket. Put some in cash, some in bonds, some in shares and possibly some in property or another ‘alternative asset class’ such as gold or even classic cars. By so doing, you will be making sure that at least part of your savings doesn’t fall. For example, when the stock markets were crashing in 2008, investments in government bonds were racking up capital gains of 30% or more. And if your pot is not big enough, there are plenty of investment trusts or unit trusts who will diversify on your behalf.

And, finally, if you are investing in the stock market, don’t invest it all at once. Regular saving, so called ‘dollar averaging’ means that you don’t put all your money in at the top of the stock market cycle and also that you do put some money in when shares are cheap. Regular saving avoids the classic small investor’s temptation – to buy at the high in the heat of a stock market boom and to sell when prices have gone down.

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• Saving time and pennies
• Is tax avoidance only for the rich?
• Private equity - who's paying for their profits?

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• You and your money: personal finance in context
• Debt and borrowing in its wider context
• Introduction to bookkeeping and accounting

About the author

Janette Rutterford is Professor of Financial Management at the OU Business School, having previously worked in corporate finance and investment. Jannette's research includes pension funds, equity valuation and investment history, in particular the history of women and wealth.

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Credit Crash Britain

In a series of special reports the Money Programme team investigate the issues that are affecting all of our bank balances: Credit Crash Britain.

In the UK, home ownership is high, with successive governments encouraging home ownership for a number of reasons – the Conservatives because they think home owners are more likely to vote for them, Labour as a way of taking the cost of providing social housing off the government balance sheet. We are now a nation of home owners, relatively high in comparison with our European counterparts, especially Germany and France, but still not as high as in the US. Although, in Ireland, Norway and Spain home ownership is even higher.

Home ownership statistics should be treated with caution – different countries measure them in different ways. For example, it depends what you mean by a “house”: using the US definition, four out of 10 homes in India would fail to qualify. Also, in a growing population, for the percentage of home owners to stay still, the number of house owners would have to radically increase. For example, in the US, the number of households increased by 10 million in the 1990s and yet the home ownership rate increased from 64% to 67% during that decade. In the UK, the big increase was between 1951 and 1981 – 28 percentage points – largely due to the sale of council houses at below market rates.

Buying a house at a discount to the market price is a ‘no brainer’. Similarly, in the US, mortgage interest payments are tax deductible, while rental payments are not, making buying relatively attractive compared to renting. Tax deductible interest on mortgages also encourages borrowing up the hilt – the more you borrow, the lower your tax bill.

Toy house on a calendar.
[Image © copyright Photos.com]

In the UK, mortgage interest tax relief was abolished in 2000. But buying is still attractive for tax reasons – there is no capital gains tax on your main residence, however much you have made. When the capital gains tax rate was 40% on everything else, that looked attractive. And , in any case, you could take advantage of low taxation by setting yourself up as a ‘buy to let’ investor, with tax-deductible mortgage interest payments and a reduced capital gains tax rate of 24%. And all this was happening at a time when the mortgage market was deregulated, with traditional banks competing with building societies to offer attractive loan packages. They were able to offer so-called “fixed rate” mortgages – in practice for only 2 or 3 years, with borrowers expecting to be able to refinance at the end of this lock-in period with another attractive offer.

The rent versus buy decision is clearly partly a financial one. In a rising property market, it is easy to persuade yourself that if the mortgage costs the same as the rent, it is worth buying for the potential tax-free capital gain. And we all get sucked in. If we don’t buy, so the argument goes, we will lose our toehold on the property ladder. And that means only being able to afford a smaller house or flat in a less desirable area when we do – as we all expect to- eventually buy a property.

But we tend to forget that the property market is just that – a market in which prices go up and down and – worse – where liquidity can dry up much more easily than in a stock market. In a falling market, you may not be able to sell at all. My sister is trying to sell her house and has had the sum total of three visits from potential buyers in the past nine months.

The property market is a market in which prices go up and down...liquidity can dry up much more easily than in a stock market

In a rising market, we also tend to forget about the high costs of buying and selling. For example, renting a flat for £300 a week will cost around £15,000 a year on a flat worth say £350,000. But buying a flat for £300,000 will involve £10,500 of stamp duty, that is, the equivalent of 8 months’ rent. And that is before taking into account the legal fees, the estate agents’ fee on sale, the cost of the HIP, and the fees attached to any mortgage.

But there is a key non-financial reason why we don’t rent as much as say in Germany or France - security of tenure. In the UK, rental agreements are typically for 1 year with a possible break at 6 months, for both furnished or unfurnished homes. You’ve hardly had time to get settled in and you may be on the move again.

In France, furnished lets are similarly short term. But, the most common form of let, unfurnished, is for three years. The person who rents can give one month’s notice at any time; the landlord has to give six months’ notice at the end of the three years and only if there is a very good reason, such as they want to sell, or a close family member wants to move in. And, whatever the rental agreement you have, and whether or not you have paid your rent, you cannot be thrown out during the winter, between November and March.

I once asked a successful entrepreneur what was the best financial decision he had ever made. “Buying my house in Hampstead”, he replied. He had made more money in the property market than from his successful business. I think it is sad that we should in a sense be forced to buy houses and become experts in plumbing, electrics, and painting and decorating. I would far rather delegate that to the landlord, and get on with my work at which I am much more competent! The only problem with renting is the lack of a long-term rental contract to give me peace of mind. Maybe, instead of trying even harder than ever to encourage home ownership, the government could try to sort out the rental market instead.

Listen to this blog post on our Money & Management podcast.

Weblinks

• Where's My Mortgage Gone transcript
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About the author

Janette Rutterford is Professor of Financial Management at the OU Business School, having previously worked in corporate finance and investment. Jannette's research includes pension funds, equity valuation and investment history, in particular the history of women and wealth.

Subscribe to Janette Rutterford's posts

 

Blogging about

Credit Crash Britain

In a series of special reports the Money Programme team investigate the issues that are affecting all of our bank balances: Credit Crash Britain.

In 1979 I needed a £500 loan from my bank (with whom I had been a customer for 18 years) to buy a distinctly dodgy second hand car. At the time I was a Lecturer at Aston University. To get the loan approved I had to meet the manager of the bank branch. I put on my suit, prepared my ‘case’ and yes I got the loan – but not before the manager had got to know his customer a little bit better.

Today, as a Lecturer at The Open University, I could, if I wanted, turn on my computer click the mouse half a dozen times and get a loan for £18,500 (equivalent to over £5,000 in 1979 money) without talking to anyone. And I thought we were in the middle of a ‘credit crunch’! Oh well, it saves on dry cleaning costs!

Credit card.
[Image © copyright AbleStock.com]

Of course the intervening 29 years may have changed the assessment of my credit worthiness ..so perhaps we are not talking about a like-for-like comparison. But during the intervening years there has been a ‘sea change’ in the access to and availability of credit. This change has had a hugely influential impact on the economy, on the housing market and on people’s lifestyles.

So how and why did the credit environment change, and are the recent developments in the financial services sector now threatening to take us back to the years of more considered and tighter credit?

The increasing availability of credit can be traced back to the so-called ‘liberalisation of financial services’ in the 1980s. This much used term relates to the changes in the financial services industry, prompted in part by government legislation that encouraged financial services providers like banks and building societies both to expand and diversify their activities, and to become more competitive in their operations.

Changes occurred quickly. Prior to this ‘liberalisation’ you were normally expected to save with a building society before applying to it for a mortgage. Even if you were granted one you had to queue - mercifully not literally - for the funds. Relationships with banks and building societies were long term and people did not tend to flit from one provider to another as they do now.

Prior to this 'liberalisation' you were normally expected to save with a building society before applying to it for a mortgage

Post ‘liberalisation’ the financial services providers competed on price more competitively and marketed their products more keenly (witness the ‘junk mail’ we still receive). The benefits for the consumers during the sustained boom from the early 1980s until the past year (interrupted briefly, and with some pain, by the slump in the housing market from 1991 to 1994) have been obvious.

Readily available credit fuelled a boom in house prices, making all home owners feel wealthier. New entrants into the financial markets – particularly the credit card market – provided a further dimension and scale to the growth in personal indebtedness sustaining in its wake a consumer boom throughout the country. In past fifteen years the level of personal debt in the UK has ballooned from £400 billion to nearly £1,500 billion - a staggering £1.5 trillion of outstanding mortgages, loans and credit card debt!

For the providers of financial services business was good. With credit booming profits rose whilst the credit exposure to the borrowing was (and is) contained by the growing value of property against which the vast majority of the debt (currently 84%) is secured.

A love affair was in place: the public loved the lifestyles that cheap and readily available credit could provide. For the lenders the expansion of credit meant growing balance sheets, growing profits and growing pay for those running the businesses.

A love affair was in place: the public loved the lifestyles that cheap and readily available credit could provide

So how and where did it all go wrong? The immediate source of the current problems was the collapse in the sub-prime mortgage market in the US. This did not directly impact on households in the UK - rather it meant that the funds UK financial institutions relied on to finance their lending dried up as banks became more reluctant to lend to each other.

The drying up of funds pushed up the cost of credit and triggered a fall in house prices – since availability of credit is a key house price driver. The fall in house prices has made households feel less wealthy and so discourages consumer spending. The fall in the price of property, against which most personal debt is secured, has made lenders more cautious about their lending policies.

For those borrowing - or seeking to borrow - the current environment is the worst for decades. Lenders have tightened their lending policies and increased the cost of borrowing - for example by ‘risk-adjusted' pricing on higher risk loans.

The impact of the debacle in the financial services industry - particularly the demise of HBOS and Bradford & Bingley - has also diminished the volume of credit available to households. The capacity to meet credit repayments has also been squeezed by the impact on household budgets of rising fuel and utilities prices.

For those lending - and there is not much sympathy for the institutions whose lending policies are deemed to have fuelled the boom-bust in the credit markets - there is the prospect of arrears, bad debts and losses. The weakest will lose their independent existence as HBOS,  Alliance & Leicester, Bradford & Bingley and Northern Rock already have.

Having spent nearly thirty years in love with credit many households and lending institutions are now left ruing their financial relationship.

Listen to this blog post on our Money & Management podcast.

Courses

• You and your money: personal finance in context
• Master of Business Administration

Weblinks

• The ethical marketeer
• You and your money interactive
• Join the discussion

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• Watch the trailer
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About the author

Martin Upton is lecturer in finance at the OU Business School. Previously he spent 20 years in treasury management, including 12 years as Treasurer of Nationwide Building Society. Martin's particular interests are financial services, the housing market, financial markets and risk management.

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